Month: November 2022

Fed Sees Risk of Big Declines in Still-Lofty US House Prices

The Federal Reserve suggested on Friday that lofty home prices could be susceptible to steep declines after big run-ups in recent years on the back of ultra-low interest rates.

“With valuations at high levels, house prices could be particularly sensitive to shocks,” the Fed said in its semiannual Financial Stability Report released Friday.

Though housing price increases have slowed recently as the Fed has raised interest rates, valuations remain stretched when compared with such metrics as rents, the central bank said. It also cited “strained” liquidity conditions in the Treasury and some other crucial financial markets; elevated leverage at hedge funds; and high commercial real estate prices when compared with market fundamentals. (…)

“Today’s environment of rapid synchronous global monetary policy tightening, elevated inflation and high uncertainty associated with the pandemic and the war raises the risk that a shock could lead to the amplification of vulnerabilities, for instance due to strained liquidity in core financial markets or hidden leverage,” Fed Vice Chair Lael Brainard said in a statement accompanying the report. (…)

• New Home Cancellations increased Sharply in Q3 “Significant shift in market conditions”

(…) In general, cancellation rates doubled or tripled in the most recent quarter compared to 2021.

Toll Brothers reported a cancellation rate of 13.0%, well above their historical rate of 7%. During the housing bust, Toll Brothers cancellation rates peaked close to 40%!

For D.R. Horton, the 32% cancellation rate was well above their normal rate in the 16% to 20% range. During the housing bust, Horton’s cancellation rate was close to 50% for a couple of quarters in 2007 and 2008. (…)

Speaking of cancellations, this chart explains why manufacturing activity will keep declining:

@MichaelAArouet

Facebook Parent Meta to Lay Off 11,000 Employees Meta Platforms said it would cut 13% of staff, embarking on its first broad restructuring to cope with a slumping digital-ad market and falling stock price.

(…) Twitter cut roughly half of its staff last week. Snap Inc. said in August it would cut roughly 20% of staff, or more than 1,000 employees (…). Business software company Salesforce Inc. also started laying off employees this week. (…)

• Tech Layoffs Reflect Worsening Outlook

(…) “The job cuts are only the start and the tip of the spear. Larger and more thoughtful companies are starting to understand that capital is fleeing investment in the stock market into ‘safer’ assets like bonds or treasuries as interest rates rise,” said Wesley Chan, an investor and former tech leader at Google who developed early Google projects including Google Analytics, Google Voice and Google Ventures. He is a co-founder of early stage investor FPV Ventures.

“The downturn has kind of started but it hasn’t hit bottom and will get bad, very quickly, likely sometime mid next year,” Mr. Chan said. He expects a decline in demand for marginal or luxury areas like crypto, grocery and food delivery services, “neobanks,” and high-end travel and beauty. (…)

• Rivian’s Losses Mount as It Continues to Burn Through Cash [BTW, RIVN reached $180 in Nov. 21. Closed yesterday at $28]
• Beyond Meat Reports Weak Sales and Mounting Losses [BTW, BYND reached $220 in Jan. 21. Closed yesterday at $12]
• Carvana’s Earnings Crash Spurs Bond Selloff [BTW, CVNA reached $370 in Aug. 21. Closed yesterday at $7.60]
• Redfin Shuts Home-Flipping Business, Lays Off 13% of Staff [BTW, RDFN reached $98 in Feb. 21. Closed yesterday at $3.25]
• [BTW, ARKK reached $160 in Aug. 21. Closed yesterday at $32.50]
• [BTW, ARKF (Fintech fund) reached $65 in Feb. 21. Closed yesterday at $14]

“Long ago, Ben Graham taught me that price is what you pay, value is what you get.” (Warren Buffett)

China Property Crisis Imperils $1.6 Trillion of Local State Debt

China’s deepening property crisis is piling pressure on a $1.6 trillion corner of the country’s onshore bond market, as cities and local administrations step in as white knights to bail out troubled developers in a state-backed bid to aid the sector.

After replacing builders as the biggest buyers of land earlier this year, the nation’s so-called local government financing vehicles, or LGFVs, have now become the main purchasers of half-finished projects of defaulters including China Evergrande Group. Their increasing involvement in real estate has analysts raising red flags.

Moody’s Investors Service says that could weigh on the credit profile of these state funding agencies. While no LGFV has defaulted in the current cycle, Bloomberg Economics isn’t ruling out one ahead. Though China’s loosened monetary policy has largely pushed onshore borrowing costs to the lowest in years including for most LGFVs, average credit spreads on some of the worst-performing LGFV local bonds have almost doubled since mid-January to nearly 10 percentage points. (…)

A potential default could cause another convulsion in a market, where LGFVs’ 11.6 trillion yuan ($1.6 trillion) of notes account for about a third of China’s local corporate bonds. (…)

David Qu and Chang Shu at Bloomberg Economics estimate total LGFV debt, including bank borrowings, to be as much as 60 trillion yuan, or about half of China’s GDP. Defaults would have major consequences, they said. (…)

Also unraveling:

@Sino_Market

Asian Property Debt Woes Worsen as Indonesia Shows More Distress The bonds of Indonesian property companies are slumping, adding to signs of property debt distress that’s been deepening in China, South Korea and Vietnam.

(…) The mounting strains come as property firms in more countries grapple with slower sales and higher borrowing costs. (…)

Rising interest rates around the world are exposing risks that have accumulated in property markets, juiced by cheap funding during the pandemic. South Korea rolled out fresh measures to help its struggling real estate market on Thursday in the form of additional guarantees to project financing. (…)

FTX on brink of collapse after Binance abandons rescue Sam Bankman-Fried’s crypto exchange dashes to fill $8bn hole as Sequoia writes down equity on ‘solvency risk’

• Binance Walks Away From FTX Deal Crypto exchange Binance said it would walk away from an initial offer to acquire its competitor FTX after a review of the company’s finances.

• Crypto Has Reinvented Bank Runs FTX’s crisis is a reminder of what is right about traditional finance

(…) The exact problems that faced FTX remain unclear. Were they primarily related to the treatment of customer assets or related more to the firm’s own assets? Further complicating matters, the line between a bank and a brokerage isn’t always clear in crypto, where one firm can effectively be your bank, broker, exchange, lender, market maker and so on. That creates many opportunities for things to go wrong.

If crypto is to survive the winter, it might need to universally adopt and prove it is using some of the conventions of traditional finance, or “tradfi,” such as ironclad segmentation of customer money and clearer lines between those different services. (…)

But how about first demonstrating actual, real world, usefulness…

• Crypto’s FTX Moment Shows Danger of Centralized Finance With No Central Bank After Binance agreed to takeover rival FTX, the danger is obvious: There’s no one big enough to rescue Binance

It also shows finance’s “me-too” effect, its impact on valuations and on naive investors. ZeroHedge revels on this:

• Here Are All The Other Funds That Are Losing Billions In FTX

In a tweet late on Wednesday, venture capital giant Sequoia Capital said had written down the entire value of its stake in FTX, a little over $210 million. (…)

A smaller venture fund, Multicoin, told investors Wednesday that about 10% of its assets under management were affected. (…)

We start at the top, where we find the “who is who” of clueless momentum chasers, who over the years somehow got confused with credible, diligent investors: we are talking of course about Tiger Global, which is down 55% this year (and is about to be down a whole lot more) and of course the fund that we once dubbed the bubble era’s “short of the century“, SoftBank. (…)

There are more funds, of course: Third Point and Altimeter Capital Management are among hedge funds that recently participated in funding rounds for Sam Bankman-Fried’s once-high-flying crypto exchange. Brevan Howard Asset Management’s Alan Howard, the family office of Paul Tudor Jones and Millennium Management founder Izzy Englander also chipped in as angel investors, alongside celebrities including Gisele Bundchen and Tom Brady.

There were many others: FTX also attracted capital from the Ontario Teachers’ Pension Plan, Sequoia Capital, Lightspeed Venture Partners, Iconiq Capital, Insight Partners, Thoma Bravo and Masayoshi Son’s SoftBank.

Tiger Global and Ontario Teachers’ first invested in FTX in December 2019 in a funding round that valued the company at $8 billion, according to PitchBook data. Both topped up their wagers in October 2021, giving FTX a $25 billion valuation, and did so again in January, the data show. Some of the other firms and individuals backed FTX in July 2021, paying cash to participate in a $1 billion funding round that valued the crypto exchange at $18 billion. (…)

Remarkably, as ever more clueless pedigreed investors piled up to fund this fraud of epic proportions, the valuation went super parabolic, and after two early rounds in 2019 and 2020, FTX got its first real outside funding in July 2021 when it pocketed $900MM at a valuation of $18 billion in its Series B round; this was followed by two more rounds, the most notable of which was Series C when ts valuation exploded to a staggering $32 billion. It was around this time that Scam Bankrupt-Fraud started naming sports stadiums, and imagined a world in which FTX would buy Goldman.

The chart below is the definitive proof that even (or rather especially) the smartest investor do no homework before allocating huge amounts of capital. (…)

More to come, including margin calls and another contagion…

Naturally, the SEC will now step in…

Russia orders troops fall back in Kherson Russia’s defense minister and a top general told troops to fall back from Kherson city to the eastern bank of the Dnipro River. Ceding control of the regional capital would mark a major retreat.

Lastly:

Trump Is the Republican Party’s Biggest Loser The WSJ Editorial Board: He has now flopped in 2018, 2020, 2021 and 2022.

• With No Red Wave, Trump Is Out at Sea By Karl Rove

Retailers in the US Push Big Holiday Discounts to Ease Inventory Avalanche

If last year’s holiday shopping season was characterized by empty store shelves and a race to meet demand in a healthy US economy, very different concerns have emerged just 12 months later: overabundance and sinking sales.

American retailers are sitting on so much inventory that brands — particularly for apparel and housewares — have resorted to listing their goods on resale websites, hosting sample sales, giving stuff to employees, offering deep discounts and even throwing goods away. (…)

The overhang is leading to canceled orders, a sharp slowdown in global trade growth and stagnating factory activity.

(…) analysts and warehouse operators say it will likely take most of next year to wring out the excesses. (…)

“Even just in the past three days, we’ve seen some of the biggest or most valuable brands in the world contact us for help with excess inventory,” Kaplan said. “It’s a full tidal wave at this point. We need the customer to be spending, and until that happens, the product’s not going to move.”

FYI, the Chase card spending tracker 9through Oct. 31) is pointing to a 0.6% drop in MoM Control sales in October. Nominal sales are clearly weak since last March.

• Recession Watch: no rescue from excess savings

(…) Part of the reason why the excess savings have not had a larger or longer-lasting impact on aggregate demand is because of how they are distributed across the income brackets. In dollar terms, the largest portion of those excess savings has accrued to the highest income quartile, as the chart below shows. As a rule, the higher your income, the smaller is the proportion of it that you spend: the rest you save.

And something similar is generally observed when it comes to ‘windfall’ shocks to income, like the government transfers. So, on the face of it, the more that excess savings are accrued by the higher income groups out of the windfall transfers that occurred during the pandemic, the lower the marginal propensity to consume you would expect to see.

However, the story is actually more nuanced than that. The excess savings accrued by the richest quartile were not in fact built up thanks to the transfers, which were small relative to their income. Instead they were accrued thanks to reductions in outgoings among that income group during the pandemic. In other words, they spent less than usual, probably because many opportunities to spend (such as on luxury travel and tourism or hospitality) were not available.

So the richest quartile have built up savings primarily because they were not able to spend as much as they might have wished during the pandemic, and/or because they chose to accrue higher precautionary savings during that period. Either way, the impact on aggregate demand now that the pandemic appears to be receding might be different than if those savings had come from fiscal transfers.

It is hard to be sure how much of those excess savings will now be spent, or over what period. The normal assumption in most macroeconomic models is that in the long run, consumer spending increases in proportion with income – so a 10% increase in income will lead to a 10% increase in consumption. Note that this long-run relationship can hold no matter what the marginal propensity to consume. (…)

What happens if the highest income group accrues an extra $1 trillion in savings? In the long run they will increase their spending by the same proportion as that excess saving is a proportion of their income, right? At its peak, the $1 trillion accrued by the highest income quartile of the US population accounted for roughly 12% of their annual household income.

So consumer spending should go up by 12% as well, in that income group, right? Well, no ‒ not necessarily.

The difficulty is that the excess saving is a one-off, a windfall, not a permanent increase in income. So the rational thing to do is to consider how much ‘lifetime’ income has increased, by spreading that windfall across all one’s future income. Then the percentage impact on consumption in each year would be tiny.

It turns out in most studies that consumers do not behave ‘rationally’ in that way. They tend to be much more myopic – focusing on the short term, with a bigger impact on consumption from windfall shocks to income than lifetime smoothing would imply.

So at one end of the spectrum you have a 1:1 percentage impact on annual consumption in the first year after the shock to savings (implying the top quartile spend an additional $570 billion or so in the first year); at the other end a tiny marginal increment proportional to the effect on lifetime income.

Fathom’s baseline assumption is in the middle: half the ‘excess’ saving will be treated as income in the first year across all income groups: more of that will be spent at the lower end of the income spectrum, less at the higher end.

Zooming in on the highest income quartile specifically, Fathom’s baseline would be consistent with around $300 billion of the $1 trillion in excess savings for that group being spent within the first year after the shock to savings – about half of that income group’s usual marginal propensity to consume out of income.

But the story does not end there. Because, over the same period, there has been another shock affecting that group: the shock to financial wealth. (…) some $7.1 trillion (around 18%) has been wiped off the value of the S&P 500 since the start of 2022, thanks to the war in Ukraine, the slowdown in growth and the increase in interest rates that have occurred over the same period.

Fathom’s proprietary macroeconomic model, GESAM, suggests that a 17% reduction in financial wealth would result in a 1.3% reduction in consumer spending, all else the same, with the bulk of that change occurring within the first four years. But, since the bulk of financial wealth is owned by the highest income quartile, the impact on their spending must be larger than for other income groups – perhaps two or three times as large (our model is silent on this question).

Therefore it is reasonable to assume that a hit to financial wealth like we have seen will tend to reduce consumer spending by the highest income quartile by around 2% to 3% in the first year after the shock. It turns out that 2% to 3% of consumption of the highest income quartile is around $200 to $300 billion a year.

In other words, the net impact of excess savings and a reduction in financial wealth for the highest income quartile in the US is probably close to zero. We should not look for much support for growth from that part of the population. To the extent that excess savings will support consumer spending in the US, that support is likely to come from the third and second income quartiles, where the dollar quantities are large enough to matter and the hit to financial wealth is probably smaller.

High-frequency indicators such as Google mobility trackers support this assessment, in the US and elsewhere. Mobility around retail and recreation venues is still some 10% below its pre-pandemic level in both the US and the UK, while it is close to its prepandemic level in Germany, France and Italy and a little above that level in Brazil. These are among the activities that the higher income groups held back on during the pandemic, and they are now flatlining below the pre-pandemic level, with no sign of imminent recovery: if anything, rather the reverse.

All of this suggests to us that without substantial support from macroeconomic policy, a recession in the US is now looking increasingly likely. And that support is unlikely to be forthcoming, with the Fed signalling further rate hikes to come.

Monetary Policy Stance Is Tighter than Federal Funds Rate

From the San Francisco Fed, Monday:

The Federal Reserve’s use of forward guidance and balance sheet policy means that monetary policy consists of more than changing the federal funds rate target. A proxy federal funds rate that incorporates data from financial markets can help assess the broader stance of monetary policy. This proxy measure shows that, since late 2021, monetary policy has been substantially tighter than the federal funds rate indicates. Tightening financial conditions are similar to what would be expected if the funds rate had exceeded 5¼% by September 2022 as opposed to the actual rate of 3-3¼%. (…)

When only one tool was being used before the 2000s, the stance of policy was directly related to the federal funds rate. However, the use of additional tools and increased policy transparency by FOMC participants has made it more complicated to measure the stance of policy. For example, in 2021–22, the FOMC lifted the funds rate target off zero and began a historically rapid pace of rate increases. It also slowed and eventually began reversing its balance sheet expansion. During this time, the FOMC provided guidance about its plans through its statements and public remarks by officials. In such an environment, the level of the federal funds rate target does not adequately convey the overall stance of monetary policy. (…)

When the FOMC uses additional tools, such as forward guidance or changes in the balance sheet, these policy actions affect financial conditions, which the proxy rate translates into an analogous level of the federal funds rate. In other words, our measure interprets changes in financial conditions as if these conditions were driven solely by the funds rate.

The proxy measure suggests that the stance of monetary policy has recently been substantially tighter than the federal funds rate alone would indicate. Whereas the FOMC moved the target funds rate above its zero lower bound in March 2022, the proxy measure had already moved positive in November 2021 and increased quickly thereafter. By September 2022, the proxy rate was above 5¼%, much higher than the actual funds rate. This difference reflects additional tightening from using forward guidance and the balance sheet. Accounting for the broader stance of policy and comparing the proxy rate to simple rules suggests U.S. monetary policy tightened sooner and more sharply than has been generally recognized.

Effective federal funds rate and proxy rate, 1976–2022

Source: Federal Reserve Board of Governors, Freddie Mac, The Bond Buyer, Moody’s, and authors’ calculations.

China Producer Prices in Deflation for First Time Since 2020

• PPI declines 1.3% y/y in Oct. compared to 1.5% expected drop

• CPI rises 2.1%, while core inflation is unchanged at 0.6%

(…) “China’s core CPI is now the lowest among major economies and is even lower than Japan’s,” said Liu Peiqian, chief China economist at NatWest Group Plc., adding that the subdued recovery in domestic demand was contributing to deflationary pressures. (…)

• Lockdowns Spread as New Omicron Variants Evade China’s Zero-Covid Net China’s manufacturing hub of Guangzhou locked down more of the city as the country struggles to contain the worst coronavirus outbreak in more than six months.

China Expands Financing Tool to Support Ailing Developers

The National Association of Financial Market Institutional Investors widened the bond financing program to about 250 billion yuan ($34.5 billion) for private companies including developers, the regulator said in a statement, without specifying the previous size of the quota. The ways to support such financing include bond guarantees, credit enhancement and bond purchases, it said, adding that the move is part of efforts to stabilize the economy and could be expanded further if needed. (…)

The program could help the private sector, but might not be sufficient to completely address the issues real estate companies are facing, said Lu Ting, chief China economist at Nomura Holdings Inc.

“Developers still face mounting bond repayment pressures in coming months,” Lu said. “We expect no major policy changes in the property sector until at least March 2023.”

While the above slow mo crash is being gradually rescued by the state, this other slow moving accident is gaining speed. Who’s going to rescue it?

Cryptocurrencies fall after FTX-Binance turmoil spooks investors

Cryptocurrencies saw a second day of sharp declines on Wednesday, as investors continued to fret about the stability of the sector and the financial health of major exchange FTX despite plans for a rescue deal from bigger rival Binance.

Crypto giant Binance signed a nonbinding agreement on Tuesday to buy FTX’s non-U.S. unit to help cover a “liquidity crunch” at the rival exchange.

The proposed deal between high-profile rivals followed week-long speculation about FTX’s financial health that snowballed into $6 billion of withdrawals in the 72 hours before Tuesday’s deal, raising questions about the solvency of one of the world’s largest crypto exchanges. (…)

“… the whole thing still looks like a dark hole. We are not sure how contagious this could be, but I believe institutions need to show their proof of reserves ASAP. Confidence does not recover before that,” Zeng said. (…)

Binance is also under investigation by the U.S. Justice Department for possible violations of money-laundering rules, Reuters reported last week. That is one of a series of investigations this year into Binance’s troubled history with financial regulatory compliance. (…)

• “I think if this bear market has proven anything, it’s that the emperor has no clothes,” Marc Weinstein, partner at crypto venture firm Mechanism Capital Ventures, said. “Even seasoned institutional investors can get swept away investing in hot deals at unreasonable valuations in a bull market.” (Bloomberg)
• Bloomberg News’s Tom Maloney reports that the Softbank Vision Fund, Singapore’s wealth fund Temasek and Ontario Teachers’ Pension Plan sunk $400 million into the exchange at a $32 billion valuation in January. [Also Tiger Global]
• As recently as Monday morning, SBF sought to reassure customers in a tweet, saying, “FTX is fine. Assets are fine.” (Axios)

Recall that FTX last spring acted as the backstop for failing crypto firms. Bloomberg’s Joe Weisenthal:

FTX on the other hand was perceived as one of the highest quality exchanges, with some of the most professional practices. Sam [Bankman-Fried, “SBF”] was the face of crypto in DC. And of course a major donor to politics and non-profits. So for his empire to implode is similar to a safe asset imploding.

The industry has been raw and mistrustful ever since the collapse of entities like Luna, Celsius and 3AC. This is like all those, but even more damaging.

More damaging? Stay tuned…

• Sam Bankman-Fried’s $16 billion fortune is eviscerated in days
• BTW, ADG recalls that, in March 2021, FTX signed a 19 year, $135 million deal for naming rights to the arena hosting the National Basketball Association’s Miami Heat. No slam dunk.