Stealth Super Slowdown of Fossil-Fuelled Economy

Coronovirus has implications as a control of the economic ebb and flow we can expect from 2020 onwards. From global government efforts to mitigate climate change. A "Super Slowdown" of the "Fossil-Fuelled Economy" is the necessity.

Coronavirus started in December 2019 is now reportedly expected to become a pandemic virus, at least according to some "cheap" expert (as in paid-for) who was rolled-out by BBC News. The globalisation of the virus was the headline-news story of the day. As we will observe, the re-named virus, officially "covid-19" is causing business and economic disruptions.

Coronavirus Distraction More Than "Disruption"

Never mind that being the headline news, but on the same day of 24th February 2020, on which journalist Julian Assange is facing a sham hearing on whether he should be extradited to America. His alleged crime is exposing war-crimes of America via WikiLeaks. Journalistic press-freedom should be paramount concern for the world. This hearing in Woolwich Crown Courts (see below about this Court) is in remote South East London, where he is being held in H.M.P Belmarsh Prison.  (Update here: "Your Man in the Public Gallery – Assange Hearing Day 1" and another from Consortium News with Live Updates From The Hearing Here.)

"Woolwich Crown Court is nothing but the physical negation of the presumption of innocence, the very incarnation of injustice in unyielding steel, concrete and armoured glass. It has precisely the same relationship to the administration of justice as Guantanamo Bay or the Lubyanka. It is in truth just the sentencing wing of Belmarsh prison." Craig Murray 25/02//2020

Yet "Disruption" Evidenced By Stock Markets Tumble

 Also that same day saw US$ 1.7 trillion wiped-off global stock markets due to participants seemingly pricing-in coronavirus becoming "pandemic" category. Allegedly from shareholders selling stocks affected by coronavirus global disruptions. FPM's sister enterprise LineBall Tennis who agitated on Twitter, shown below; had an understanding of what has greater impact on wider population - loss of freedom of press or variant of common flu:

Fake Tweet! Source:Twitter @LineBallTennis, CNN

The crux of the matter as a coronavirus distraction. Our understanding is that Covid-19 is virulent variant of influenza also known as "flu". They both have similarities that both are deadly especially to vulnerable categories, as it is do do with breathing and respiratory systems of our body. Despite the media frenzy and hysteria (as they have to propagandise 24-hour news cycle), the less media-minded people understand that a much greater proportion of people die annually from the flu, than have globally died from Covid-19.

The Importance of Business-Cycles In Forecasting

We at Financial Portfolio Management understand business cycles since the fledgeling organisation's founder initiated a dissertation when at Middlesex Unversity in his youth about business-cycle boom-and-bust, specicially studying the "Kondratieff Cycle" economic cycle factors.

 Professional investor greed and fear means share price valuations are currently trending ever higher at near record levels (see proxy FTSE100 chart below). These dizzy heights justified or otherwise WILL cause speculator trader and real-money investors to expereince wild uncertainties / swings, especially before settling into a secular reversal or possible up-trend. This is a precept about technical chart analysis and mean reversion in market behavioural analysis. Which is more short-term orientated cycles of stocks and stock markets.

Proxy FTSE-100 Near Record Levels. Source: Yahoo, FPM

So what is the fundamental long-term catalyst for putting the brakes on global economic activity? Which is undoubtedly causing catastrophic human-added climate change. The evidence of climate-changing is before our eyes via high definition mainstream television news. We've seen flooding in wetter climates, droughts with forest fires and bush fires in drier climates, and so on. The evidence is numerous. Mainstream news source nowadays bang-on about it' but not as prominently featured 10-20 years back sadly; or even further back when the science and extrapolation of trends first suggested "global warming from anthropic activities".

Slowdown Or Disruption Of Economic Activity

 

Every NATO or UN country will manifest a particular "shock" catalyst which results in effective slowdown of the real and financial-market economies. 'Brexit' as global known enduring phenomenon in United Kingon, as a political movement is designed to curtail economic activities, especially through short-term disruption to free movement of people and goods. Since Brexit is 'not done' despite Tory rhetoric and shock democracy of 2016 referendum, reverberating as "Brexit In Name Only", it is business as usual. FPM as firm Brexit-supporters say sham European Union is continuance of neoliberalism (see FPM's meaning of 'neoliberalism'), but rolled out to the newcomers from former U.S.S.R eastern European countries. When eventually Brexit gets done intra-European Union short-haul flights will be controlled. As necessary to meet 2030-50 set emissions targets for countries. Also as a footnote, UN climate-change summit will hosted by Glasgow, Scotland UK dubbed "COP26".

FPM's Understanding of Neoliberalism in Manifestation - Source: Naomi Klein "The Shock Doctrine" 2007

FPM is expecting further geopolitical fall-out from de-globalisation of the socio-economic political process. As well as Brexit, "America First" and POTUS Trump's border-wall war-cries are all part of stealth-super-slowdown in neoliberal globalisation, but dressed-up as populist nationalism or quarantined cornoavirus. FPM further believe there is global backlash to the liberal democracies of the West, which has prosperously benefited the few at the cost of austerity for the many. Not a political slogan but a fact. Austerity or poverty also rationlise the wider population from affording holidays and travel. Therby reducing economic activity.

Of course referring to the wealth-inequality issue, and circumstances of 2007-09 global financial-crisis. Especially how the ridiculed taxpayer via its government saved banks and other financial institutions from insolvency. After banks' self-regulating profligacy of virtually gambling. And of course regime-change agenda followed by western democracies in the Middle East / Gulf region. To keep the war-machine in these old-power countries chugging along. Again, who is paying for waging wars in the Gulf? Yep, the #stupidelectorate taxpayer! (Stupid Electorate hashtag was coined for some of the UK voters after the December 2019 General Election defeat in UK of Jeremy Corbyn and Labour Party)

"Stealth Super Slowdown" has to happen in the name of saving the planet and environment as we know it. We all acknowledge China's emergence to eminent economic super-power is the future driving-engine of global economic growth in the 21st Century. So by China peddling its soft-power of business-wealth potential, it can perhaps direct a new sustainable way of achieving economic life other than from fossil-fuels based industries. But the shock-impetus towards stealth slowdown of China's powerhouse economy is underway, see below excerpt from Reuters. Reminder that generally China's economy has been growing at double-digit rate or averaging 7% economic growth.

Economic data for January had been fairly upbeat, but analysts have since sharply cut their forecasts for economic growth in China. J.P. Morgan now expects Chinese GDP to shrink 3.9% this quarter, while Capital Economics sees it outright contracting. Reuters 27-Feb-20

Guest Post: Last Forty Neocon Years - Kaput!

Mark Blyth’s Incisive Post-Crisis Takedown: “A Brief History of How We Got Here and Why”

Posted on August 5, 2019 by Yves Smith

Mark Blyth, the Brown political scientist of “The Hamptons are not a defensible position” fame, has a must-watch video of a presentation, A Brief History of How We Got Here and Why, which we’ve embedded below. We’re featuring it despite the lack of a transcript. Even though Blyth presents a fair bit of detail that is familiar to readers, he manages the difficult task of synthesizing it in a way that generates novel observations. It doesn’t hurt that Blyth is also colorful and a high bit rate transmitter. This video is a fantastic way to get people you know who’ve started to develop doubts about orthodox stories about how the economy works to see thing in a different light.

Blyth argues that the world has been through three policy regimes, using computers as an analogy and arguing that like computers, capitalist systems all have the same major components and economic ideology is the “software”. 

The regime first was the gold standard, which allowed for international capital mobility without inflation, favoring capital over workers. That regime worked from roughly 1870 to World War I. As academics like Peter Temin described in detail, after the Great War, European economies tried to restore the gold standard, and Temin argues that those efforts produced the Depression.  
The Depression ushered in policy changes which eventually produced the next era, which started after World War II. The policy objective of this era was full employment. Cross-border capital flows were restricted, countries were more autarky-like than now, and governments were economic activists. Blyth quips that no one knew who central bankers were back then.

This era broke down with the 1970s inflation. But Blyth argues that the trigger was that the share of GDP going to labor had become intolerably high to businesses and investors. Inflation also favors labor over capital by eroding the real value of debt. The answer to that was the capital-favoring, globalist, inflation-hostile neoliberal era.

Blyth stresses that what happened after the 2008 financial crisis, which resulted from the failings of the neoliberal regime, the effort to restore the old system, is an unnatural response which will only lead to intensification of the underlying stressors, like rising levels of private debt, greater income inequality, and even more financialization.

Only an economist could see climate change as hopeful. Blyth sees climate change as discrediting the populist right, which has no answers for this problem, and libertarians, who are allergic to state action, when that will not only become necessary but desperately sought after.

"I don’t want to diminish your appetite for watching this video-talk by saying more, particularly since a lot of the fun of a Blyth talk is in his asides where he present things as obvious, and even if you kinda-sorta knew that particular factoid, you probably didn’t have as pithy a formulation as he does."

The video!

Principal K Kristian Siva's of FPM addendum chart:

 

The Rotten Financial System - ROT$

The Economics of Things Post-2008

Since the near melt-down of financial system in 2008, which warranted £4.3 trillion of taxpayer / public funds, little has changed in economic fundamentals. Fund Portfolio Management - FPM staffers collectively hoped for the catastrophe to morph into the reversal of neoliberal economic policies, which technically would mean taking control over the money supply.

In essence forward to now, and the global banks are again making above-normal profits at their pre-2008 levels and huge bonuses after paying some hundreds of billions in regulatory fines for their gross wilful sabotage of the economic and financial system. How were executive-level bankers fraudlent? Simply by making irresponsible loans that they were able to take-off their own books or have subsequent accountability for, by packaging and passing on to long-term savers. The corruption of the whole related entourage of businesses and regulatory authourities were vividly shown to be perfunctory and illusionnary, in substance. Shame!

Back then, the trust in the banking system, among bankers themselves, was lost as banks would NOT lend inter-bank, thus the overnight-lending which is lifeline of daily banking operations ceased / froze. (FPM ask whether this really potentially was crippling industry relying on credit lines for their daily operational cash-flows, as cited for using public bail-out funds?). The melt-down was averted by central banks, led by America's Federal Reserves flooding the banking systems with new capital. Printing money out of thin air is one the basic functions of a central bank as lender-of-last-resort.

This "Bernake Parachute" of money onto Wall Street banks practising casino-banking was in stark contrast to the infamous Great Depression of the  1930s, where a stock-market bubble was blown via wreckless margin-lending by banks / brokers. Hindsight reviews of that financial crash suggested that the Federal Reserve - FED did not act quickly to avert a domino effect collapse. So this time round Ben Bernake as central banker and prompted by US Treasury offcial decided and persuaded their elected politicians that they could raid the public coffers to again make solvent the private financial institutions which were bankrupt, which were floundering. Remember, this time round a credit buble had been blown with housing-stock as reference asset. In 1930, the reference asset fuelling the greed for get-rich-quick mania was stocks and shares.

By parachuting money onto Wall Street banks - as a prototype president for averting a severe financial crisis instigated by the FED and with other global central banks to follow - the policy makers DID NOT TAKE CONTROL OF MONEY SUPPLY. Central bankers did the opposite i.e loosening or expanding money supply through what the media euphemistically peddled as  "Quantitive Easing - QE" and numerous other acronyms for basically printing money - i.e. digital records. Control of money-supply meant assuring how much money in a system. Of increasing and decreasing according to the economic situation prevailing. 

This model of robber-baron banking has been around since the beginning of the 20th century (get and read free PDF about the clandestine creation of the FED as model of banking-monopoly in "The Creature From Jekyll Island"). FPM have been disillusioned to see same extractive exploitation of the public entering into the 21st century and the new Millennnium. The authourities, regulations, and legislative-laws that are supposed to act as checks and balances to protect the public are virtual and deliberately non-effective.

Fund Portfolio Management's mission is therefore to now earnestly educate, as opposed to indoctrination as dumb economics in schools, colleges and banks; but to promote the greater good for the public by provoking thought activism of the unfairness of the financial system. Related bretheren of the banking dynasties is the industrial military complex. As well as other industrial-cousins such as oil and gas, travel and transport etc. Taking our cue to from one the greatest activists known to FPM's principal Krishna FPM dub the money-allocating financial system "Rotten Financial System - ROT$".

P.S. note and disseminate the ticker / stock symbol for the rotten financial system; also note the 10th anniversary of the symbolic-gesture of Lehman Bank going-bust marking the "Great Recession", as media-muppets term it.

A Social Economic & Ecolological Paradigm

FPM principals have been expecting a rise in interest rates for some time since 2011: with hindsight of time-told evidence and our longstanding10-year deleveraging economy paradigm (as foretold by economists Reinhart and Rogoff), FPM revise its forecast to a low-rate global environment into the medium future. The reader will understand that this is a bold revision at a time when financial services are not only vying for higher rates but indeed anticipated from Federal Reserve between 4Q14 and 1Q15. Remember that the economic recovery in terms of positive GDP growth started in 2Q09, therefore now beyond the halfway stage of the mooted 10-year economic stagnation paradigm, FPM would not be surprised to see no more than an overall 25 bps hike between 4Q14-1Q15. 

Make no mistake, any small rate-hike would not be a signal for policy shift in interest rates. Rather yet another in a long line of smoke-and-mirror tricks to timely bolster waning economic confidence. A show of stable economic growth would be the intended effect. That greatly acknowledged behavioural science characteristic of market participants called "confidence" is at junctures seemingly crucial to a world of rational investment decision makers! The recent Wall Street Journal op-ed promoted this as "private animal spirits" - more criticism of this stale brand newspaper in our next YAALA series.

Based on traditional economic understanding FPM forecast in earlier blogs that a first interest rate hike would happen by 1Q14 this year - Doh! In fact in Europe earlier this month the central bank there imposed unprecedented negative interest rate policy on banks depositing money at the European Central Bank, citing flagging economic recovery. It is the same situation in the United States of America, as reflected in mentioned WSJ article trumpeting for policy shift:

“The Federal Reserve's Open Market Committee on Wednesday stuck to its path of reducing its bond purchases by $10 billion a month… [it also] Fed slashed its growth prediction to 2.2% for 2014, which is down sharply from the nearly 3% forecast that it made in March… The move reflects the minus-1% growth in the first quarter, which could turn out to be even worse with revisions… Predicting future growth is notoriously hard, but this is the fifth consecutive year that the Fed has been too optimistic…” WSJ June 19, 2014

 FPM perceives developed countries’ economic weakness as structural and cyclical in the long-term. The developed countries being at structural saturation levels in terms of economic activity will not necessarily be expected be characterized by excess spending-power, which would certainly contribute to inflation increases. Yet unofficial economic growth policies of these anaemic growth economies are through population expansion via immigration which is helping to minutely tick-up GDP growth, lest the statistics reflect the real structural economic downturn. We validate this unpopular growth policy through the discontented nationalist voting patterns in the recent European Union elections. Using a corporate finance comparison, the population expansion economic policy could be said to be growth through acquisition rather than organic expansion. In the UK, the Office of National Statistics, confirmed a population of "64.1m in mid-2013 – up 400,600 on mid-2012". This is not a Y-O-Y rise in new births (from "Bonking Britain"!) or newly registered population but net inward migration.  Below are some 'stats' for the number-crunchers about  US jobs growth versus population:

Increasing Population and Real Unemployment (Source: EPI.ORG)

The proponents of interest rate rise suggest that a benign policy environment induces more borrowing and creating asset bubbles. Indeed only those afflicted with foolhardy short-termism imprudence would lead to detrimental debt addiction. A rational approach to bearing debt is also logical.  Debt accumulation is a choice prudently assessed on the ability to service one's debt i.e. pay the interest and coupons on expectations based on interest rates. Therefore, in a world of job insecurity and excess spare capacity of long-term skilled unemployed workers, the low-rates are helping debt-ridden suicide jumpers away from the precipice! That debt-indulgence is an insidious and malign threat to an entity’s well being only tells half the story. Indeed, have we forgotten or are we distracted and detracted from the debt crisis of many developed countries. Remember the US “fiscal cliff” wrangle over raising the debt ceiling (as related aside, the war in Iraq alone has cost taxpayers US$ 4 trillion), European Union debt crisis, and the downgrading of national credit ratings (including US and UK losing its top triple-A ratings). We believe these were real and impending threats in an already feeble pretentious global economic recovery - we don't know from certitude of analysis that these were not PR-contrived media diversions.

1) FPM regard moderately rising actual inflation as necessary and good in context; despite that age-old phenomenon being manipulatively managed down in the recent decade at 2%-5% levels in most developed and to a lesser extent in developing economies. Inflation is necessary at least as a sign that economy is over-heating i.e. too much money chasing too fewer good in context of increasing economic growth. Yet the reality is that the 'real money' is not chasing those goods and service. Instead printed money or credit expansion by multiple governments towards propping-up the global credit markets is misallocating taxpayer resources, ever since the Great Recession of 2007-08, and also well before from pump-and-prime stimulus policies. Inflation also indicates firms have growth expectations through pricing power – which would suggest future corporate health. Corporate war-chest spending on share-buybacks is indicative of low potential economic growth, and done for stimulating share-price performance and enhancing the wealth effect. Whereas the obfuscated reality is that input-factor costs and raw materials are being driven-up through commodity and other asset speculation stemming from unprecedented massive credit expansion; or the now tapered “Quantitative Easing” programmes. These higher input-costs are passed to consumers in clandestine ways that does not show up in measurement of actual inflation levels. So without letting the cat out of the bag i.e. inflationary worries, interest rate rise is not a threat. Economic fundamentals still appear weighted towards deflation tendencies so is a rate increase is not possible in that context. Introducing the next reason why interest rates won't rise rapidly is that actual and expected inflation diminishes the value of debt i.e. debt destruction.

2) With North American aggregate debt alone estimated at some US$ 60 trillion, any fast or sharp rise will utterly destabilise governments, corporations and individual debtors, sinking the economies into further cycle of recessions and recoveries; a cycle which when reflected upon over time we like to describe as a "new equilibrium restorative pause" (at least in the non-BRICS countries). Rapid economic growth is not good for economies - doing things right takes time! Sustainable future requires long-term planning NOT mammon-orientated short-termism: 'make a buck out of whatever good and hell breaks out'. FPM aim to reinforce that by hijacking a logo from the Climate Revolution activists "What's Good For The Planet Is Good For The Economy".

Source: Vivienne Westwood Ltd, FPM

While investment strategists are tuned to economic fundamentals like strong employment and rising inflation to connect the timing and actuality of eventual interest rate rises, FPM thinking holistically  believe there are socio-economic ecological political factors that maybe underpinning a low rate environment for many years to come. The much needed multi-billion dollar reallocation of capital towards lowering fossil-fuel dependency requires long-term massive global investments at lower costs of financing. More below.

3) US Government policy of tapering or turning-off its monetary stimulus is not the same as the US Fed or other central banks being ready to raise interest rates. In fact the ideas are at opposite ends by degrees! The occasional lip service and rhetoric of talking-up the possibility of climbing interest rates is not a real threat for the over-riding reasons economic fundamentals given in point 1 and 2 above. FPM’s interpretation for the Federal Reserves’ neutral stance on interest rates is not only that economic fundamentals warrant it, but also politically speaking that there would be back-lash short of a people’s revolution if the political classes again seemed to be helping unscrupulous banks and other sizeable asset owners. Simply put, banks are in the business of lending money / capital and creating wealth. Yet if returns on lending / investment activities are low i.e. small interest receipts and other capital asset returns, then banking activities are not as profitable. This somewhat appeases and satisfies the struggling masses of the ‘ragged trousered philanthropists’ i.e. you and me. Witness the estimated 50,000 people protesting against austerity cuts in London UK on Saturday 21^st June.

Another political impetus for a low growth economic environment despite forecasts and sugar-coated propaganda, stems from global climate concerns. For real! There is finally a real recognition that global climate change induced by man’s activity is a real threat to the sustainability of planet Earth. On the basis of resulting increase in air travel, carbon emission and 'carbon footprint' concerns, FPM's does NOT support the clandestine government policies of population expansion by immigration. The exigency of proactive action is now! If the biggest markets for man’s productivity and economic activity can be stalled then carbon dioxide CO² emission is also reduced. Without delving too deeply into the science of climate change, we are on the cliff’s edge towards increasing the average global temperature and setting of a sequence of ecological consequences with disastrous effects for humanity. We recommend web-searching Bill McKibben or simply go to website 350.org where he explains the urgent maths of climate change. FPM’s projects in funds and investments is oversight of emerging trends and assessing their value. And indeed we see global warming and solutions as a game changer with great enterprise value. Don’t take our word for it visit Risky Business.

Investment Sector Outlook for 2013: “Credit is a Lover on the Re-bound?”

FPM considers the macro speculation that policy makers’ credit cycle stimulus is in musical terms at a moderata end in 2013. The high flying segments of the credit asset class are behaviourally like a spurned or unreciprocated lover on the rebound to the next ‘pick-me-up’ lover. FPM’s analogy is that eventually this new quickly formed, on the bounce love-affair is checked. And in the end not lasting or enduring, as it was a hastily formed affair from hurt ego and pride following a more secure stable relationship or courting. We feel the stellar ‘dead-cat bounce’ from credit-bubble bursting in 2007-08 should unwind. Especially so in mortgage credits and leveraged loans. Not forgetting that these segments of credit were in greater proportion the underlying constituents of structured products dubbed ‘toxic’ CDOs, CLOs et al. The credit collapse should eventually be precipitated by the un-leashing of inflation expectations. Turning off credit stimulus is the first step. This view rhymes with some professionals predicting a strong equity market rally. Also, in this article we review our credit opinions expressed in September 2011 in “Credit Markets @Optimistic Workout Inflexion Point”. The hedge funds we recommended in that article, such as the Chenavari ABS Toro and the CQS ABS funds FPM put on “Review / Redemption” rating.

Our view is based on policy-lead from the US Federal Reserve and understanding of cyclicality in capital markets. The Fed’s minutes of its recent Federal Open Market Committee’s (FOMC) December 11-12 meetings hinted at reversal of policy by some of its members. Particularly toward halting the policy of monthly purchases of US$45 bn in Treasuries and US$30 bn in mortgage related securities.  Minute extracts:

“Several others [of the FOMC members] thought it would probably be appropriate to slow or to stop purchases well before the end of 2013… citing concerns about financial stability or the size of the balance sheet, which has grown from $869 billion in 2007 to over $2 trillion.”

In hindsight, policy makers or establishmentarianism turning off the bankers’ credit tap has been inevitable, or put another way long-time coming. Especially when considering the subsequent bargaining in ‘fiscal-cliff’ discussions at end-December 2012: whether to continue Bush-era tax holidays for all except US$400,000+ earners. In budgeting terms, something often has to give, or philosophically “be sacrificed”. FPM are aware that until final budget and national debt discussions are concluded in late February /early March there might yet be other compromises in American austerity drives. Set your calendar alarms to March 1^st announcements on this.

After all, how long can the prime-and-pump machine churn-on towards inducing improved confidence and sentiment in economic activities and capital markets. The Great Depression could not be one if it was over in five year! Despite reserve-currencies ‘printing-money’ and the associated moral hazards in an increasingly interconnected global economy, concerted economic policy response has been credit expansion.  Inflation could still well be a scenario for debt devaluation. Inflations has been abated/ repressed or even manipulated in reserve-countries. Statistically, inflation is failing to measure a relevant representative basket of goods and services. Multiple academia and statistical research have distortedly indoctrinated professionals and public that ‘perceived inflation’ was higher than ‘actual’ reported cost of living because the basket constituents that were rising were repeat purchase items like food and other living day essentials. So price of cars or other durable goods and services deflating would be less noticeable, yet these heavily-weighted goods in the inflation basket more influence the ‘actual’ inflation. So like manipulation in LIBOR, we may understand that inflation measurement baskets are not representative to most of the population, who do not buy new cars repeatedly! Admittedly there are other prevalent inflation-mitigation factors than simply a pacifying behavioural finance explanation for biased inflation data. For example, China and other developing countries are globally exporting deflation through the activation of lower cost-base economy and globalisation trends in general.

The above mentioned moral hazard comes from the value of money becoming meaningless.  Capital is meant to be a finite resource in most economic models, even in an open economy.
Yet modern finance practice has advocated printing money aggressively to stave-off recessions and depressions. Castles in the air capital can be written-down to realign assets at fair value. Remember that majority of capital is ultimately quantified and recorded in global accounting and banking systems as assets and liabilities in global forex terms at any one time – excepting “fringe economy” / black-economy activities.

Writing-off of all bad debts based on bubble-valuation of certain house and financial asset prices was not an option for the banks at the onset of the financial crisis. Propping-up valuations interferes with laissez-faire market principles. Cited in ‘main stream media’ due to the strategic importance of housing and financial sectors to the wider economies (…remember even the short-term commercial paper markets froze at height of crisis due to the helm of the then capitalism masters). Even though some $600-800 bn of ‘bad vintage’ subprime was inevitably written-down signalling the catalytic economic downturn. Almost like a script from past crisis. Write-downs are no longer an option, as bank-sponsored toxic assets are now in the hands of taxpayers as collateral for government guarantees and loans. Unsecured lending is not feasible with fragile confidence in counterparty-risk. The better quality credit tranches have been hand-picked by cash-rich investors like Blackstone, Blackrock and other asset managers at fire-sale or heavy discount prices. For now it seems to be a pirate’s or vulture’s bonanza for them and their investors. FPM envisages a probable scenario in which these re-capitalised assets and their underlying debt obligations become distressed as the government credit taps is turned-off. As general interest rates tick higher so will bad debt problems.

If the ‘toxic or legacy asset’ collateral against which Governments have been lending to banks do not continue to perform in line with overall reasonable economic expectation when ‘Quantitative Easing’ stops, then another wave of write-downs and blowup-entities should follow. Fear may persist keeping capital expenditure and corporate deal making shallow. FPM certainly believes in this probability of ‘multiple-dip recession’ cycle started in 2007-08. Markets are reflecting this in sideway trending benchmarks with intermittent bull-runs, flash-crashes and dips. Economists Reinhart and Rogoff have suggested a 10-year of de-leveraging process.

Remember that allegedly towards fiscal-boosting the economy amid a bubble-de-leveraging cycle, the emergent alternative media libertarians (enabled by blogging and internet at large), have slavishly and bearishly flagged and criticised policy maker plaster-fixes. Government will no doubt have assets and liabilities in their ‘bail-out’ accounts that do not match, and therefore require further deficit-funding to keep fundamental balance sheet integrity. Together with ‘austerity’ impact and other public repression possibly causing populist uprising in mainstream European Union and American states, geopolitical risks are high on the cards. Already this is occurring in fringe states. Where protests and demonstrations occurs in UK and US, authorities have only been too quick to quosh it. Witness ‘Occupy Movements’ in London, New York and other cities.

If only vigorous and unabated expansion of fiscal and national deficits of global Governments could continue! To bring the vividness through a comparably simpler model, think of pension funding mis-match in assets and liabilities for settling retirement policies and the consequences on retirees. Many pension-dependent hopes and expectations have again been dashed in these too often de-leveraging cycles. Resulting in postponing retirement or reduced perpetuity income in effect living poorer than promised. Even if retirees were money-wise and fortunate to have multiple assets such as properties and investment portfolios they will still feel wealth destruction. Less retirement homes in the sun are being bought in affordability terms to settling for a mere sunshine holiday.

This is why we believe banks and other financial intermediaries are siphoning off / farming-out money to other institutions as investments. Hedge fund and buy-out firms are filling the void of traditional bank lending and securitisation. This shift in liabilities has hidden risks too. Consider the effect and implications of Volker rule as evidence. The global banks themselves have still to maintain sufficient ‘individual bank-tested’ reserve capital to insure against future non-performing loans and gradually correcting house and financial asset prices. Hence why traditional global banking prospects have and are in the mire (in spite of upbeat ad hoc quarterly earnings reports). Alternative financial firms are rampantly being established as the shadow banking system. If Volker is acting in a  middle-man / double-agent role between financial and government interests, then who is serving? The newly-established asset managers mentioned above and host of others are known to FPM via its Fund Manager Transactions proposals.

Following on from our last thought-leader: Investment Sector Outlook for 2013: “Volatility in Vogue”, some of the above mentioned political market-interference has caused Vix-measured implied-volatility to drop to a five-year low in S&P 500 equities. And no doubt other financial and capital asset volatilities have also markedly diminished. Simply from lower economic activity caused by current and future macro economic uncertainties.  These fundamental uncertainties are referred to in financial cant as ‘sentiment and confidence’. Whether one is a consumer, investor in capital, Government employee or importer/ exporter (gdp=c+i+g+[x-m]), doubt causes catharsis or stagnation until resolve is found in endeavours to carry on economic transactions. The current economic stagnation, or euphemistically anaemic growth, is a macro fundamental fact which has been alleviated to-date by Governments, and therefore by implication future taxpayers. Though we are economically not out of the woods, policy-makers can no longer interfere with free money or ‘crowd-out’ capital investors by effectively capping interest rates. Fundamentally disrupting creative-destruction by controlling the price of capital to save Strategically Important Financial Intermediaries at the expense is taxpayer is moral obliquity and lacking sense. FPM believe policy-makers’ job is done after having successfully prevented economic freefall post-Lehmans 2008, now we feel they should let go off the economic reins and let free markets indulge in creative-destruction. FPM has less care for QE supporting banks and more will for interest rates to rise - yes it does matter whether one is a still net lender or borrower after maelstrom of the past five years.

As if to affirm direction for the economy at this forward-looking time in the Gregorian calendar, we in the UK have seen the headlines about the almost final demise of yet another long standing high-street retailer. His Masters Voice or HMV, a music and media distributor with a 90-years history and currently 230 stores employing 4,000 staff went into administration. This was after failing to secure a £300 mn credit line from its suppliers in a last ditch effort. The bank had breached its banking loan covenants in December. This circumstance surrounding its failure, not too dissimilar to the closure of the venerable Kodak company at the beginning of 2012, not only highlights flaws in its commercial raison d’etre but to us reflects a ‘zombie’ company unable to improve deteriorating asset values on balance sheet while outweighed by its liabilities. Creditor call was triggered without recourse to sufficient internal restructuring. We hope restructuring of the old business is possible in administration and emerging as a leaner brand. We had witnessed other UK high-street brands disappear, mostly new arrivals but also back in 2008 an age-old Woolworths. Behavioural finance suggests that when investors are apathetic to corporate and market foundering news over time then they are also expectant of real good news.  

So we have ultimately predicated that the credit asset class will become increasingly volatile before an eventual correction in prices from a) speculation and eventuality about the inevitable interest rate hikes and b) subsequent credit-quality concerns and defaults in the economy overall and c) triggers / catalysts in distressed credit sectors that have thus far re-bounded and propped-with-stimulus. Such as sovereign debt in European fringe countries with contagion into Spanish and French sovereign debt concerns, student loans in US, credit and consumer loans, commercial mortgages, leveraged loans.

Credit souring is as inevitable as re-bound affair not lasting. Lastly we leave you with a vogue investor’s voice on the credit cycle. Ray Dalio, founder of US$120 bn AuM Bridgewater Associates, speaking at a conference in December 2012 said “The biggest opportunity will be shorting bond markets around the world”. He also suggested that interest rates will rise in late 2013.

FOR A TELL-TALE PERFORMANCE ANALYSIS OF 20 SELECT CREDIT / BOND ETFS,

PLEASE DO CONTACT US: kristian.siva@gmail.com

Credit Markets @ Workout Inflexion Point

During the private equity leveraged-buyout boom and the housing bubbles in the US and other developed countries, and up to the height of the financial crisis, demand for leveraged- and mortgage  loans came mostly from structured finance offerings such as collateralized debt obligations (CDOs) and mortgage backed securities (MBS). Since the 2007 sub-prime driven unravelling of structured credit portfolios, with inherent flawed model assumptions, the subsequent clearing of debt markets has been incessantly underway. The ‘workout’ in identifying fair-value of these hard-to-value assets, which had been battered in the ensuing ratings downgrade and plummet in mark-to-market valuations, is showing dividends. 

As a turning point and until the sovereign debt turbulence of August 2011, there are both obscure and vivid examples of the clearing of credit market. Adjectives for loans, credit and debt have become prominent in recent financial vocabulary, with descriptions such as “delinquent”, “non-performing”, “in forbearance”, “distressed”, “credit quality” etcetera. The premise for FPM’s inflexion in credit assertion is based on interest rate and credit cycle and plethora of credit-related market activity.

Micro Workout Amid Macro Stability

The micro-economic aspects of asset bubble economies of 1998-2007 are and were being fixed amid macro-economic monetarist stimulus, introduced by the then chairman of the Federal Reserve, Alan Greenspan. Asset bubbles bursting, whether related to emerging markets-, technology / TMT, or sub-prime housing, inevitably leads to recession and recovery periods.  Recent stimulus included the massive re-capitalisation of banks to preserve their regulatory capital requirements from the effects of withering asset quality valuations in structured securities (and ‘ballooning’ notional CDS exposures – look out for “CDO vs CDS”, an FPM note to follow). The new paradigm of easy credit from central banks’ “pump and prime” such as low interest rates and government tax relief prevented asset bubble recessions spiralling into protracted deep ones while solvency issues were sorted at the micro level.

FPM has collated some evidences of active loan markets including the purchase, unbundling and selling of pooled loans, and higher recovery values. Also indicative of restoring economic order and confidence are the multiple legal cases surrounding mortgage securities mis-selling etcetera. Litigation and settlements may not seem a credit quality issue other than its confidence-restoration link to the structured securitization debacle. FPM’s insight suggests these litigation and resultant outcomes affect investors holding these mortgage debt or leveraged loan secuirities, at least their recovery values in situations of loss-making positions. Mortgage litigation losses remain a dark cloud looming over financial services. As is the impact of forebearance. The Bank of England warned in its semi-annual Financial Stability Report this year that it may explain the lower rates of arrears and repossession for homeowners in this recession than in the last (See FT article: Iceberg of soured loans hides true losses).

Mortgage Loss Litigation 

After the fire-fighting period post-Lehman 2008, the SEC started initial investigations into the mortgage-bond selling by suing Goldman Sachs in April 2010 over the Abacus 2007-AC1 deal. Then broad-based investigations and subpoenas ensued in the autumn / fall of 2010. The results of law suites, litigation and settlements are now unfolding in the 2H11; as are independent fresh cases such as the July 2011 lawsuit filed by China Development Industrial Bank. CDIB claims that Morgan Stanley "misrepresented the risks" of CDO called Stack 2006-1 Ltd.

Some of litigation workout examples augur mixed fortunes for indicted banks. In June 2011, it was reported that JPMorgan Chase agreed to pay $153.6 million to resolve US SEC charges that it misled investors in a mortgage-related CDO, named Squared CDO 2007-1, it constructed for Magnetar, an Illinois hedge fund. Similar settlement later that same month when Bank of America completed an agreement to pay $8.5 billion to settle claims related to subprime-mortgages securitization (via mortgaged backed securities). This last settlement represents one of the single biggest, related to 20 institutional investors including fund management behemoths BlackRock and Pimco. Clearly such steps, ‘clears the slate clean’ of the malfeasance in securitization and ensuing financial crisis. As caveat, this author’s optimism is tempered by headline risk of such reported settlements.

Stop Press: FPM told you so! As of 2^nd of September 2011, Federal Housing Finance Agency of the US is suing 17 banks for losses related to mortgage security mis-selling. Adding to the current on-going market jitters, the 17 listed global banks including securitised mortgage players such as GE and Countrywide Financial and First Horizon National, had their stock prices marked down between 2 and 8 percent on the news. These traded lower due to additional liability to banks’ capital stemming from the potential new litigation losses (up to $20 billion mentioned) related to the selling of some $120 billion of RMBS.

FPM long-memory research reminds us that banks churned out $1 trillion plus of CDOs and the like. These structured ABS with multiple ‘tranches’ led to some $2 trillion of writedowns and credit losses for global financial firms since the start of 2007.

Also, since 2000 the leveraged loan market grew significantly, and at the end of 2007, the market for leveraged loans was worth $1,061 billion, making it the largest corporate debt market.

As for the biggest asset-play market, US mortgages not held by Government Sponsored Entities (GSEs) but in private mortgage conduits accounted for nearly $3,000 billion at the end of 2007. These non-agency MBS in the US accounted for $1,800 billion at the end of 1Q2011, according to the Federal Reserve. Remember the total mortgage debt outstanding held by major financial institutions, Federal and related agencies and mortgage pools or trusts is $13,700 billion at end-March 2011 (similar in size to the entire US GDP).    

CLOs Transform into Mutual Fund Offerings

The institutionally-held investments in securitised debt, rashly generalised as ‘toxic assets’, are being repackaged into simpler mutual fund structures (both closed-end and open-ended varieties). These portfolios’ constituents are primarily private-equity leveraged loans and/or securitized home equity loans with short- to medium-term refinancing instruments.

Indicative of credit workout, noticeable that in March 2011 Apollo Global Management, a top 5 global private equity firm providing loan-financing; and a large exchange-traded fund (ETF) manager Invesco PowerShares, both launched portfolios where the underlying is ‘legacy’ loan paper.

Apollo’s closed-end fund (CEF), a long-only mutual fund with limited issuance of shares and traded on exchanges, constitutes floating rate notes or FRNs.

FPM’s new-trend-notice reflects that FRNs have become “attractive option for refinancing loans”, as confirmed by Paul Hatfield on Creditflux.com. The pre-financial crisis model of borrowing short-term through asset-backed commercial paper (ABCP) market, and lending / investing in longer-term higher yielding assets (such as CDOs andCLOs), is a model that broke down during the financial crisis, by its functional seizure.

Invesco Powershares’s offering became the first ETF for corporate bank loans. The ETF tracks the S&P/LSTA US Leveraged Loan 100 Index, a basket of the 100 largest and most liquidly traded loans.

Investors have allocated cash into mutual funds that buy such loans, increasing the assets managed to $37bn as at February 2011, according to Lipper the fund tracker.

AXA Investment Managers in Paris, with a division specialised in structured credit, were one of the early users of the CEF structure for ABS investments via its Volta Finance (ticker: VTA). Which invests in corporate credits, CDOs, ABS, leveraged loans, and infrastructure assets. Since the launch in October 2006 pre-crisis and the systemic crash in 2008 there is an up-trending price recovery (See Chart 1). Another Amsterdam listed CEF, Tetragon Financial Group (ticker: TFG), launched in 2007 also experienced similar price slump in the 2008 but has bounced back stronger (see Chart 2). Further primary fund analysis is required to understand the performance difference, whether due to better underlying loan picking or refinancing etcetera.    

  

Another notable structured products CEF vehicles is the Carador fund (ticker: CIF) managed by GSO Capital which is owned by the Blackstone Group.

FPM believe this repackaging of underlying credit is better suited to CEFs as opposed to open-end vehicles or the defunct and complex CDO model. With mutual funds the investor acquires only stock / equity in a regulated, pre-defined product life-cycle with access to the performance of underlying commingled loans. Unlike CDO structures there is no holding of subjectively rated tranche debt paper or “waterfall payment” of interest or principal related to seniority of bond-holding and correlation of loan defaults etcetera. All investors in mutual funds have equal economic interest as equity shareholders with income and capital growth expectations, ceteris paribus.

Distinguishing between open-end and closed-end mutual fund structures investors are advised to consider CEFs as long-term investments. A secondary market in CEF fund sales-trading ensures possibility of liquidity. Where the bid-offer price for the underlying CDOs, inclusive of securities transaction cost, is perhaps referenced to a proxy benchmark, say Markit CDX North America Investment-Grade Index. Already analysts have expressed some concern at illiquidity in the underlying loan market.

Structured-Debt Hedge Funds

According to HFRI hedge fund indices and FPM analysis the top-performing investment strategy is the Relative Value Fixed Income Asset Backed.  This strategy’s benchmark produced 39.8% compound over 4 years ending June 2011 (or 8.7% annualised). FPM research recommend performance and diversification strengths of eight hedge fund managers with expertise in fixed income and particularly securitised ABS, either in mortgages and/or leverage loans (as listed below). For example, the mortgage funds’ securitised debt strategies may specialise in pre-payment sensitive mortgage-backed securities, which show little correlation to other markets. Leverage loan plays include Par structure CLOs.

Aladdin Capital	The Aladdin Opportunity Fund was launched in mid-2008 with the goal of profiting from knock-down value across asset-backed securities (ABS) markets.
Cairn Capital	European ABS and leveraged loan specialist launched its Cairn Capital Structured Credit Fund “to capitalize on current dislocations and opportunities across the spectrum of structured credit”
Cambridge Place Investment	Cambridge Place specialises in asset-backed debt and related instruments, including private investments and real estate.
Chenavari Financial Group	Toro Capital 1 has produced gains of 27.8% over the first six months of 2011 and 338.7% since inception in June 2009, and managed by 36 years old Frederic Couderc.
CQS (UK)	The CQS ABS fund has returned an annualised 35 percent since launch in October 2006 to date end-June 2011.
GSO Capital	The credit trading arm of Blackstone Group launched GSO Capital Opportunities Fund in 2008, and gained 13.5% net internal rate of return. They have launched a second fund in June 2011.
Structured Portfolio Management (SPM)	SPM's mortgage backed arbitrage fund Structured Service Holdings claimed top spot for 2010 in Bloomberg’s Top 100 Hedge Funds with gains of +49.5% (following the fund's 2009 returns of +134.6%)
Tetragon Financial Management (formerly Polygon Credit Management LP)	Senior secured bank loans (aka leveraged loans) constitute the main assets of Tetragon Financial Group.  TFG gains exposure to these assets through existing and new investments in the residual tranches of CLO and CDO products.

Table1: Source: FPM

Plethora of Credit-related Market Activity (See also Addendum below)

The unbundling of securitized debt and subsequent realization of value is the credit market propping mechanism or trend that FPM are highlighting in this note. Repackaging debt is in itself is not a new financial solution: remember the Brady bonds of the late 90s, where an emerging markets bubble and subsequent debt overhang from bank issuers, were resolved by the debt being wrapped with IMF guarantees and sold into the market.

The equity tranche or first loss tranche of structured ABS is even in some leveraged loan structured products showing value. The above mentioned Volta Finance fund managed by Axa Investments reported in June that its CLO residual holdings or CLO equity positions were being marked at 75% of par on average. CFlux’s secondary CLO index levels of Dollar denominated equity tranche shows 46 cents on the dollar as at end August 2011. This suggests an entry point in such plays. Arbitrage across the spectrum of structured credit certainly exists. CLO management agreement transfers is an active market due to nuances of terms contained in the structures and discounted prices of these assets with inherent time-value if not as yet intrinsic value. (Await forthcoming structured product “CDO vs CDS” FPM research).

Citi Capital Advisors, a unit of Citigroup, led firms taking over the management agreements of $4.5 billion of CLOs in the US in August alone. There are also plenty evidences of fund raising to get in on the action. CQS, a hedge fund mentioned above, announced in June that it is capping the CQS ABS fund, launched in 2006, after it has raised $2 billion. The fund then managed $1.6 billion. Other fund-raising efforts announced at similar times this year are by GSO Capital, planning to raise up to $3 billion, and Avenue Capital aiming to gather as much as $2 billion to focus on investing in the debt of US companies. Remember this secular trend started in early 2010 of the credit cycle, where Fortress Investment Group bought two businesses with a total of $13 billion in CDO assets. Carlyle Group acquired the collateral management contracts for 11 CLO funds managed by Stanfield Capital Partners. Carlyle also took a 55% stake in a long-short credit hedge fund Claren Road Asset Management.

Also indicative of credit comeback is the Rothschild Asset Management take over of credit manager Elgin Capital. Elgin’s other credit funds had closed during the credit crisis, with the remaining business being the management of four CLOs. Consolidation in the structured products by larger well-backed institutions capitalizes on fund-raising difficulties weaker rivals face. This trend is natural and expected in the credit cycle and FPM has highlighted its significance for investors.

An obscure but relevant statistics about the state of credit markets is the level of balance sheet write-downs or write-ups of credit assets. FPM noticed that US banks’ revenues from credit trading were lower in 1Q11 on quarter-to-quarter basis with 2010. Office of the Comptroller of the Currency reported in its 1Q11 Quarterly Report on Bank Trading and Derivatives Activities:

“…The relative absence of these write-ups in 2011, compared to both 2009 and 2010, explains the difference in trading revenues in these periods.”

   

FPM interpret this “relative absence of write-ups” on legacy credit assets as signal that fair-value in mark-to-market is now accomplished, and further that credit issuance and trading is set for revival. Less credit business explained the overall lower bank trading revenues, therefore means of growing credit revenues will be an imperative for banks.

However, FPM author feels that this may come from higher interest rate environment, but that not being a credible policy option now; other credit flows will need to be substituted. Possibly, increasing syndication and trading in sovereign debt, as witnessed in August and into September this year.  

FPM’s Contrarian Credit View

The corporate credit-boom, credit-crunch and subsequent workout in the financial services sector have been cyclically profitable – with entry points provided by uncertainty in economic fundamentals, such as current concerns about policy makers’ ability to deal with sovereign deficits and debts. A case-by-case analysis is certainly warranted rather than the broad-brush treatment. As this if to highlight this concern, Bank of America through its acquisition of Merrill Lynch and Countrywide Finance still faces a situation of dealing with $1 trillion of problem home mortgages.

The final positive note is that the credit comeback started in mid-2010. Singling out the largest corporate debt markets as an example – see Chart 3 below, FPM feel confident in confirming Credit Markets @Optimistic Workout Inflexion Point, despite August sovereign debt news-flow. This assertion is time-stamped using US Market screen-shot from Google finance page on 9^th September, 2011: alternative for FPM to being a contrarian cash investor (Chart 4). 

Chart 3

 

Chart 4

Addendum 

Lloyd Bank (UK) is accelerating its sale of bad commercial property loans. In 2010 it sold about £4 bn of real estate loans through "forcing an administration or encouraging and investor exit". In May Lloyds  marketed its first sale of a portfolio of distressed property assets, making £1.8 bn in 1H11 propety disposals.
The Bank still has about £23.7 bn of troubled real estate loans, while Savills estimate about £350 bn of outstanding debt in the UK commercial property market. The sale is expected to managed by  JPMorgan Cazenove and is currently in early stages.