Almost Daily Grant's
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Thursday, April 27, 2017
But it rhymes
Those who recall the financial chaos of 2007-09 might shift in their seat uncomfortably upon seeing the phrase “innovative solutions for borrowers” in a press release headline. Wire-watchers were treated to that informative sight earlier this week, as the government sponsored enterprise Fannie Mae announced a plan to help those burdened with student loan debt qualify for a mortgage.
The mechanisms for this borrower relief? Offering the option of a cash out mortgage refinance to pay down student debt, excluding “other” forms of debt (including auto loans and credit cards from a borrower’s credit profile when paid by a third party (i.e. mom and dad), and relaxing underwriting by utilizing more forgiving calculation of debt-to-income. Reached for comment, vice president of underwriting, pricing and capital markets at Fannie Mae Jonathan Lawless estimates that the debt-to-income adjustment and cash out refi changes may provide upwards of an additional 13 million borrowers with access to mortgage credit.
(Could a stimulus in the form of a student-debt jubilee be so far off?)
This slackening of terms could be arriving at an inopportune time. Last week, Sam Khater of CoreLogic released a paper asking the simple and essential question: “Is the credit cycle turning?” He notes that of the four primary loan types (agricultural, business, personal consumer and real estate), the first three have seen a downturn in performance over the past year.
The bullish hold-out has been real estate, but as Khater reports in a subsequent analysis of loans broken out by year: “the 2016 vintage was the first year in which the serious delinquency (defined as more than 90 days behind) rate after 10 months was worse than the prior.” So far, the reversal has been mild, with 2016 serious delinquencies coming in well below those from 2010-2014 (2015 set a two decade low rate of just 0.13% through 10 months, whereas 2016 ticked to 0.17% for the comparable period). However, any change in the credit cycle warrants attention, as trends here not only exert a strong influence on economic performance, but also tend to persist for a period of years.
Evidence of an unwelcome turn has also appeared in a pair of first quarter earnings releases this week. Capital One Financial Corp. and Discover Financial Services both disappointed relative to sell-side consensus, with provisions for loan-losses leaping by 30.5% and 38%, respectively, from their levels of a year ago. Finally, Bloomberg this morning reported that banks, including Wells Fargo & Company and J.P. Morgan & Co., have grown increasingly hesitant to extend new subprime auto loans as serious delinquencies have risen to their highest levels since 2008.
Equity markets enjoy a near constant bid and options-based volatility is all but extinguished: six month VIX futures are trading at their lowest levels since June 2007, shortly before Bear Stearns disclosed problems with two in-house credit funds. Credit seems to be gradually pivoting, in the wrong direction.
Wednesday, April 26, 2017
Tech goes to heaven
Tuesday, April 25, 2017
A short story in six lines
Consider the following headlines, all from Bloomberg news, this morning:
China’s Hidden Debt Stirs Investor Angst as Defaults Rise
China Markets Reel as $1.7 Trillion in Shadow Funds Unwind
China Pledges Support for Economy, Stressing Need to Avoid Risk
Hong Kong Dollar Weakens to 14-Month Low as Rate Spread Widens
Iron Ore Seen Slumping for Years After Hitting February Peak
China Helps Make Caterpillar Great Again as Outlook Improves
As the lyricists of Sesame Street once taught us: One of these things is not like the others.
Meanwhile China’s domestic Shanghai Composite has quietly slipped to a three month low. At the same time, the NASDAQ composite index rose to its first finish above the 6,000 level, to mark a record close in nominal terms.
Trump Tweets Trudeau tweaks
In the past 24 hours, President Trump has fired a pair of salvos at America’s neighbor to the north. Yesterday, our Commander-in-Chief announced retroactive (to 90 days) tariffs on Canadian lumber imports ranging from three to 24 percent. This morning, Mr. Trump dashed off a twitter message complaining that Canada “has made business for our dairy farmers…very difficult” and threatening that “We will not stand for this. Watch!” In response, Prime Minister Justin Trudeau politely noted, “The U.S. has a $400 million dairy surplus with Canada so it’s not Canada that’s the challenge here.”
At least in the case of lumber, the cross-border dispute has been percolating for years and was seemingly anticipated by the commodities market, as CME lumber prices jumped 25% from early November to April 7 before leveling off (they finished weaker today). For its part, the loonie is testing a 52 week low against the greenback this afternoon.
Contrast this with Trump’s treatment of China, the U.S.’s largest trade partner and a country that he promised to crack down on during last year’s campaign. The Congressional Research Service writes in a recent paper that China “continues to maintain (or has recently imposed) a number of state-directed policies that appear to distort trade and investment flows.” But the President has remained firmly accommodative thus far, offering a metaphorical carrot to his counterpart in a recent Wall Street Journal interview. He recounted telling President Xi Jinping: “‘[Y]ou want to make a great deal? Solve the problem in North Korea.’ That’s worth having deficits. And that’s worth having not as good a trade deal as I would normally be able to make.”
Perhaps Trump is attacking Canada in order to provide political cover for inaction on China. America’s other traditional allies may wish to take note.
- Philip Grant
Monday, April 24, 2017
Apres Macron, le deluge? Yesterday’s first round elections in France looked to produce a favorable result for the status quo, as the May 7 runoff between establishment candidate Emmanuel Macron and nationalist Marine Le Pen will likely vault the former into power, or so say the can’t miss polls. That result would sit well with Brussels, as Ms. Le Pen had vowed to exit the union and recommission the franc, a re-denomination that would constitute technical default under existing French debt covenants. Accordingly, French sovereign debt saw a screaming rally, with the ten-year shaving 10 basis points to yield 83 basis points (compare to 2.27% for the 10 year U.S. Treasury, a security with no apparent re-denomination risk), and two year yields dropping by 15 basis points to a head-scratching negative 44 basis points. The VIX collapsed, with the spot reading dropping more than 24% to under 11 while contracts out through August sit below 15 as participants assess our new, apparently risk free world.
Amidst today’s global bid for risk assets and squashed options volatility, it is perhaps worthwhile to ponder the yawning disconnect between giddy asset prices and unmistakable voter dissatisfaction across the Western hemisphere. In aggregate, French voters who selected a far right or far left candidate virtually matched those who opted for the pro-EU “centrists” including Macron, Francois Fillon and Benoit Hamon. Stateside, a piece in the Wall Street Journal highlighting the President’s poor approval ratings contained a survey showing a striking trend; respondents who feel that government “should do more to solve problems and meet people’s needs” reached a record high of 57% in April, while those believing “government is doing too many things better left to businesses and individuals” was a mere 39%. Since the survey began in 1995, only in the fall of 2008 did the discrepancy tilt so heavily, a period that certainly stands in contrast to the levitating equity markets, steady payrolls growth and a 4.5% measured unemployment rate seen today.
What gives? Markets have increasingly become tools of public policy, their historical reflection of economic vitality seemingly dwindled. Consider a note from Deutsche Bank over the weekend, which tabulated $200 billion in global QE per month currently being undertaken among the Fed, ECB, BoJ and BoE. The Swiss National bank reported more than $63 billion in U.S. equity positions in their 13-F filing dated December 31, 2016 compared to $41 billion in the prior year, representing a bid backed by dollars and francs created at the tap of a computer button. Meanwhile, U.S. Federal debt as a percentage of GDP has virtually doubled from its spring 2001 interim lows.
These machinations have evidently failed to impress Joe, Alistair or Jacques six-pack, as evidenced by the election of Donald Trump, Brexit and yesterday’s 49%-plus French vote for far right and far left candidates. Governments around the world opted to “save” the financial system in the wake of the 2008 market cataclysm, and in doing so have further enriched asset holders while leaving the rest behind. The St. Louis Fed relays that real median household income has declined by 2.4% since 1999, marking nearly 20 years of stagnation. World central banks appear inclined to double down on their support for asset prices, but an extension of the political unrest that emerged last summer could put the brakes on this eight-year and counting multiple expansion party.
- Philip Grant
Thursday, April 20, 2017
Score one for Marc Cohodes. Canadian regulators dealt a blow to Toronto-based Home Capital Group, Inc., accusing the mortgage finance company of making “material misleading statements” over its response to the origination fraud which the company disclosed to the public in 2015.
Individuals named in the complaint included former CEO’s Gerald Soloway and Martin Reid, as well as current CFO Robert Morton. With its stock trading around C$17.5 per share from above C$39 a year ago despite relentless strength in the Toronto housing market, investors have clearly voted with their feet amidst high executive turnover and less than transparent disclosure, now underscored by yesterday’s rebuke from the Ontario Securities Commission.
Cohodes delivered a memorable presentation at the Grant’s fall conference in 2016, which included a frank analysis of the red flags he spotted at Home Cap and the unusual behavior of management. Two weeks back, he regaled podcast listeners with tales of his less than pleasant interaction with a process server dispatched by another one of his targets (specialty pharmaceuticals name Concordia International Corp.) who had opted to sue him for libel. Click below for the slides from his talk, as well as the podcast interview.
Ever seen the 2010 film Inception? The “dream within a dream” concept developed there now has a real-life doppelganger. It will soon arrive in the form of an ETF designed to track the ETF industry itself. Brought to life by Toroso Investments, this nascent second derivative will allow investors to gain “exposure” to an array of companies involved in the burgeoning ETF business. $200 million is the minimum market cap for potential components.
It was over a decade ago and for many it surely feels far longer, but the hedge fund business once commanded a level of popularity that seemingly necessitated the invention of fund of funds. Then came: the fund of funds of funds. As documented by Grant’s in the spring of 2004, the arrival of that three-tiered management-hydra turned out to bode not-well for the traditional two and twenty business model. We can only observe that the enthusiastic clamor for ETF products is approaching a similar fever pitch.
The carry trade is alive and well, but not where you might expect to find it. With the JPY/USD pair remaining well off its December highs (near 109.5 from 118 five months ago), it is Russia of all places that has emerged as the preferred vehicle for speculators to capture sovereign funding spreads from the chronically low rates available in the west.
Bloomberg reports that inflows into Ruble-denominated debt hit a record high in March at $2.8 billion, underpinning a steep 15% Ruble rally over the past year versus the greenback, in a period where the DXY index has managed a 5.5% advance of its own.
While a relief bounce in the energy complex and balanced-budget initiative has seemingly formed the fundamental basis for the bullish reversal in Russia’s finances, the striking intensity of speculative interest (Wednesday’s tender of ruble notes due in 2019 and 2033 were swamped with bids, covering the offer size by ratios of 3.18 and 3.70, respectively) serves as the latest example: If there is positive news to be had in this ZIRP-ish world, you can be sure that growth and yield starved investors will not forego the chance to participate. Risk today is missing the trade.
Risk appetite was the name of the game, as the second S&P 500 levitation in four days left the broad average higher by +1.3% for the week and back within 2% of the closing highs reached on March 1. U.S. Treasury yields ticked a bit higher in tandem to leave the curve little changed, while gold managed to stay flat despite the highest JPY/USD in more than a week.
Wednesday, April 19, 2017
A significant positive data point arrived this morning in the form of the Cass Freight Index for March. Standing in contrast to some recent harbingers of weakness, this tabulation of North American shipping activity showed a third straight month of year-over-year gains in both the shipments and expenditures components (higher by .9% and 3.0%, respectively), maintaining the upward trajectory which began in October.
The domestic rebound in activity can be primarily attributed to two factors: a reversal of fortunes in the rail business related to recovering energy prices from their 2016 nadir (the Association of American Railroads saw commodity carloads grow by 7.4% year-over-year in March), and strength in domestic shipping volumes. Perhaps unsurprisingly, author David Broughton ascribes the latter trend to e-commerce and its “outstanding” growth rate.
Perhaps more importantly, air freight has been strengthening in both the Asia Pacific and Europe Atlantic lanes, with the proprietary index created by Avondale Partners showing year-over year growth of 17.1% and 3.4% in February, marking the fifth straight month of improvement in each corridor from its 2016 levels.
While U.S. rails and e-commerce names have certainly not been overlooked by the bull crowd, (Amazon sits higher by 19% over the past 52 weeks, and the Dow Transports index by 14.3% compared to a 7.8% advance in the S&P 500), UPS has been conspicuously absent from the party. Amidst ongoing attempts at disintermediation from key customer Amazon, its shares have lost just over 5% in the last year and more than 8% in 2017 so far, while the trailing price/earnings ratio has been whittled to 17.8 compared to around 21.5 for the S&P 500.
Reporters at Bloomberg provided readers with a pertinent and at times very funny (for non-investors) update on the San Francisco based tech “unicorn” known as Juicero, a company described as a “stealth-mode juicing startup” on its Bloomberg profile page. Offering an intersection of traits near and dear to many a west-coaster including sustainable, organic cuisine and high-tech gadgetry, Juicero has managed to raise around $120 million in funding in recent years. Founder Doug Evans described his machine thus in an interview with Recode: “There are 400 custom parts in here. There’s a scanner; there’s a microprocessor; there’s a wireless chip, wireless antenna.”
The problem for the makers of the $399 (marked down from an original $700) press machine and its wide array of venture capitalist financial backers? Its end-product can be squeezed by hand at roughly equivalent efficiency, accounting for time and juice “yield”. Most investors, who quite understandably demurred on being quoted for the record to reporters Ellen Huet and Olivia Zaleski, were nonplussed by the revelation. One who bought in lamented “that their venture firm wouldn’t have met with Evans if he were hawking bags of juice that didn’t require high-priced hardware”, per Huet and Zaleski.
One investor did speak up, and remained steadfast in his support. Doug Chertok of Vast Ventures claimed he’s “still a huge fan” in spite of the revelations, terming the machine a “platform” for a new medium of food delivery. Evans, for his part, used just such a term in a 2016 interview with the New York Times. He also mused: “Not all juice is equal. How do you measure life force? How do you measure chi?”
We certainly cannot answer those questions, nor can we ascertain the fortunes of this heretofore technology/organic food “platform” that now more closely resembles, well, a juice company. We can observe that in the right speculative conditions engendered by the “right” kind of interest rates, fad products with a dubious business model and marginal prospects can endure far longer than might otherwise be expected.
Stocks caught an early bid but were unable to hold it, fluttering lower through the session to finish near the day’s worst levels with a ~.75% peak-to-trough decline on the S&P 500. Declines were lead by energy as the weekly inventory report continued to show stubbornly high levels, confounding (for now) Grant’s anticipation of easing stockpiles this spring. The U.S. Treasury curve ticked wider, helping the long end ease off the 2017 low yields logged this week, while a test of 109 in JPY/USD coincided with weakness in gold as the precious metal retreated to a one week low after notching its best close of 2017 yesterday.
Tuesday, April 18, 2017
Following their surprise (or non-surprise, for Grant’s readers) currency devaluation in December 1994, Mexico was forced to contend with a number of necessary evils, apart from Larry Summers. Hyperinflation reared its head in the form of a 43% rate of CPI growth at publication time in the fall of 1995, on its way to 52% at year end. Following a series of rate hikes, GDP went into freefall, sinking by as much as 8.1% year-over-year in the summer of 1995, before recovering in early 1996. The peso, however, made no such comeback; trading at just over six to the dollar in mid-1995, it broke eight to the dollar in early 1997 and has become weaker ever since. As Grant’s remarked, presciently, sort of, those types of conditions in this country “might cause J.P. Morgan & Co. to finance a Bernie Sanders presidential campaign.”
Credit markets were more than happy to forgive and forget. While the Mexicans scrounged to repay their bailout, Colombia managed to borrow an upsized $225 million in October 1995, at a mere 1.25% over wholesale dollar deposits. Other sub-triple-A borrowers stateside, including RJR Nabisco and Orange County, were likewise quickly “re-accomodated” (not in the United Airlines sense either). Mr. Market was telling us something: What followed, of course, were four-plus years of broad asset appreciation, interrupted only briefly by the Asian Contagion in the summer of 1998.
(original piece is linked below)
Diversified industrial-equipment supplier W.W. Grainger is seizing up. Notwithstanding an already skeptical analyst cohort (Bloomberg tabulates three buy ratings compared with 15 holds and four sells among the sell side, prior to today), a reported first-quarter combination of weaker than expected net sales, pricing deterioration, contracting margins and an accompanying EPS shortfall in both the quarterly results and fiscal-year outlook was enough to spur some acute pain for longs.
Today’s 11.4% drop left its shares 23.5% below its February peak and under the interim lows logged last fall, prior to the presidential election and subsequent spate of optimism over the economy. The gradual encroachment of retail bogeyman Amazon.com is a factor (mentioned by Grant’s in our bearish analysis of peer Fastenal dated February 7, 2014) that can partially explain this steep erosion in business, but in any event the market reaction indicates surprise at the intensity of decline. One by one, the post-election expansions in risk appetite have largely or fully reversed themselves. The primary exception? Banks and financials, as the XLF product still sits roughly 16% above its closing price on November 7. Steve Mnuchin and Gary Cohn may be doing God’s Work, but they aren’t miracle workers.
- Philip Grant
Monday, April 17, 2017
The non-eruption of a new Korean war over the weekend helped spur a solid bounce for equities, with a .77% upswing for the S&P 500 erasing the bulk of last week’s decline. U.S. Treasury spreads widened a bit as the long end reversed its early strength, while losses in the energy patch helped keep the CRB commodity index in the red. Seventeen components of the S&P 500 are scheduled to report earnings tomorrow according to Bloomberg,
When is a margin loan not a margin loan? Thanks to Alexander Hamilton’s old newspaper, we now have the answer. Securities based lending is that not-quite margin debt, and it is plainly on the rise according to the New York Post’s Kevin Dugan. It is also lightly publicized, fast growing and all but unregulated.
As with traditional margin debt, securities-based loans are extended against the value of an investment portfolio, but the similarities end there. Proceeds of an SBL may be used for any purpose other than investment securities; think yachts, starter mansions or that Major League Baseball franchise you’ve always had your eye on.
Naturally, these products generate significant fees for the brokerages that offer them. For instance, Wells Fargo advertises a base rate of 6.25%, further adjusted according to the borrowers debit balance and household assets under management at the firm. Lenders are mostly mum about the scope of this product. Morgan Stanley, one brokerage which does break out its SBL exposure, reports that outstandings grew to $36 billion as of December 31st 2016, from $28.6 billion in the prior year and $22 billion in 2014. By point of comparison, their book equity at calendar year-end 2016 stood at just over $77 billion.
Today’s Post story highlights details which should send shudders down the spines of those who remember previous leveraged-induced mishaps. As Dugan reports: “Unlike most other loans, SBLs typically have no term limits and don’t require monthly payments, even as interest compounds. Because the bank can sell off their securities at any time, borrowers aren’t required to chip away at their debt.” An un-named former Morgan Stanley broker tells Dugan that some customers are using proceeds for the one purpose that is expressly prohibited. “What they’ll do is have another account, wire the money out of [the SBL account] to a bank, and then have that bank wire to pay off margin. I have seen that.” As for the regulators, there has been little apparent push-back, with Susan Axelrod of FINRA telling The Wall Street Journal in August of 2015: “These loans are a really great option for (obtaining) extra capital if the market is producing returns. But customers have to be aware that a market downswing…would make these products less attractive.”
Dugan relates via his sources that aggregate SBLs outstanding fall somewhere within the $100 billion to $250 billion range. Meanwhile, conventional margin debt reached a new record at the end of February of just over $528 billion, a +21.2% leap from February of 2016. On April 7th, the Mortgage Bankers Association reported that the average loan size of a home purchase reached a new record high of just under $319,000 compared to around $257,000 at the peak of the last cycle logged at the end of 2007, an advance of 24%.
Past performance may be no guarantee of future results, but heavy borrowing against highly priced equities pretty much ensures trouble.
- Philip Grant
Thursday, April 13, 2017
A late spasm of selling pressure left the S&P 500 at its lowest close in an even two months, as equity markets are perhaps paying heed to the risk aversion signals recently emanating from the JPY/USD pair, industrial metals complex and US Treasury curve. Spot VIX continued its steady ascent with its first closing test of the 16 level since the election, while the energy group suffered a -1.83% decline (despite sideways action in the underlying complex) for the worst showing among S&P sector components.
Speaking of which, balance of news in the energy sector has turned positive of late beyond the un-attributable mumbles from OPEC members suggesting an extension to the existing 1.2 million barrel per day supply cuts currently in force through July 1st. The International Energy Agency reckons that the cuts are, in fact, being implemented (the agency calculates 104% aggregate compliance with the cartel’s agreement), but the ongoing realignments between supply and demand, longs and shorts, could prove to be more significant.
Both the American Petroleum Institute and Department of Energy reported big inventory depletions this week. The latter measure, which is generally more likely to influence prices, saw its first significant draw of 2017 with declines in crude, gasoline and distillate double or triple their respective consensus estimate. Run-off of apparent stockpiling by OPEC members ahead of the Jan. 1 start date seems a likely factor behind the reversal, tempered by continuing recovery in U.S. production.
As noted by Grant’s in our recent survey of the energy market (Laddered Oil Play, March 10), U.S. shale producers can undertake new projects in a fraction of the time required by majors. Accordingly the DoE has marked a pickup in domestic output (just over 9.2mbpd, up 9.6% from the July interim lows) to back within range of the 2015 high water mark, as prices have recovered from their early 2016 nadir below $40/bbl.
While the nimbleness of domestic players in responding to increased prices seemingly counts as a bearish feature, bulls can take comfort in a pair of positive developments:
DoE implied demand has seen a corresponding uptick to 17.4mbpd, the highest since September and +12.7% from the late fall lows. Finally, the listing speculative imbalance that saw CFTC spec-longs reach a record high of 556,607 net contracts in mid-February of 2017 has eased considerably. That net long position ticked to 408,382 contracts last week, a relatively prompt decline of just over 36%. While far from a certainty, the path to a higher oil price does appear to be clearing somewhat.
Quote . . . unquote
Chandler Howard, CEO of Liberty Bank, Middletown, Conn., in today’s Financial Times on the speculative tone of present-day commercial real-estate lending:
“When we’re trying to compete, we see term sheets coming through with interest-only transactions, terms going out longer and longer, some loosening of guarantees.”
Wednesday, April 12, 2017
The so-called Trump trade saw its latest round of unwinding, as the first sub-110 close in the JPY/USD pair since November accompanied reciprocal post-election highs in the price of gold. Rates likewise continue to augur something other than reflation, as the benchmark 10-year yield crept below 2.28% for the first time since November 17 while the Treasury curve has pancaked to its flattest in the past five months. As for President Trump, the campaign-trail hard-money man, he roiled markets this afternoon by hinting he may reappoint Fed Chair Yellen, after all, that he likes low interest rates and the dollar is getting too strong, “and partially that’s my fault, because people have confidence in me. [Uneasy lies the head that wears the crown.—ed.]
“Look,” the president added, “there’s some very good things about a strong dollar, but usually speaking the best thing about it is that it sounds good.”
Among the array of indicators signaling waning risk appetite, the recent downside acceleration in industrial metals prices carries the potential to inflict particular mayhem on financial conditions. The conduit of such hypothetical strife would be China, the United Nations member state that most closely resembles a margin account.
As every Grant’s reader is aware (see, for instance, “Sell a non-sequitur” in the January 13 issue), the state of Chinese speculative finance appears to be a decisive factor in the euphoric price action of those metals in 2016 (steel rebar for instance saw a +138% move from its mid-2016 trough to the recent highs), especially considering the largely unfavorable fundamental conditions which persisted throughout that rally. Now the metaphorical worm seems to be turning, as evidenced by the swift reversal across iron ore, steel and copper. They now sit 28%, 16% and 9% below their respective recent highs after an overnight tumble.
There is nothing necessarily remarkable about that development on its own, particularly as each of those commodities still resides near the middle of its individual 52-week trading range. However, the highly leveraged and financially interconnected nature of the Chinese economy could prove the catalyst for a more extended sell-off in these products (which undoubtedly act as collateral for many an encumbered speculator). Market participants are to some extent wise to these risks, as Bloomberg reports that Chinese financials are trading at their largest discount on a price/book basis since 2004.
Meanwhile, a piece in today’s Wall Street Journal makes note of tightening conditions in the Chinese corporate lending market, with a pair of rate hikes from the PBoC not helping matters. The Journal tabulates a 38.5% year-on-year decline in corporate bond issuance for the first quarter, while nearly Rmb. 120 billion worth ($17.4 billion) of issuance was delayed or scrapped entirely, a near three-fold increase over levels of re-accommodated* deals seen two years ago. If the base-metals market continues to sink, the PBoC may be forced to backpedal from its policy tightening sooner rather than later. Who knows? Maybe the Fed, too.
*copyright, United Airlines
Quote . . . unquote
“`We’re not seeing much interest on the buy side, everyone is nervous that the bottom is falling out’, said a commodities trader in Perth, Australia, who closely monitors activity on China’s Dalian and Shanghai Futures Exhanges for overseas clients.” (Reuters)
Tuesday, April 11, 2017
In spring-like fashion, the volatility freeze that has defined 2017 so far is showing increasing signs of thaw. Indicators such as the VIX index, JPY/USD pair and price of gold have all retraced their “reflation” moves following the November elections, joining the US Treasury curve which initially widened sharply following Donald Trump’s surprise victory but has since fully reversed flatter across the 2/10 and 5/30 spreads.
Equities temporarily followed suit, with an intraday decline of 80 basis points in the S&P 500 shaking the broad average from its recent trading band. Dip-buyers then performed their customary afternoon “magic” to push that SPX back above its 50 day moving average by the bell, but risk appetite does appears to be plainly abating with first quarter earnings season set to begin in force next week.
The Mortgage Bankers Association reported a potentially significant reversal in commercial real estate finance; total lending volume in 2016 saw a 3% yearly decline, and squares with the broad stalling-out seen in the C&I lending market since late last year. That pullback comes after a lengthy and virtuous run of growing issuance and shrinking loan delinquencies, as 2016 still marked the third highest volume on record (behind 2015 and 2007). Delinquencies exceeding 90 days reached a microscopic .59% from just over 4.2% in 2010.
It seems that end buyers have collectively exhausted themselves amidst these ultra-benign conditions and accompanying rise in prices (The St. Louis Fed CRE price index tabulated year-over-year growth above of 10% for 11 straight quarters through the end of 2015), as evidenced by a steep decline in property transactions. The $493.7 billion in deal value for 2016 represented a 10% yearly drop (compare to the smaller change in lending volume), while the early stages of 2017 have delivered even weaker results: $50.3 billion in transaction value through March 1 compared to $80.1 billion in the like period in 2015 (a 37.2% yearly drop).
In light of the intensifying reversal in buyer appetite and the simple laws of gravity, one may think that banks and other lenders would take a hint, but that has not transpired. Indeed, yield-famished investors are still clamoring for new deals, according to Craig Bender of ING real estate, who bluntly told the Wall Street Journal: “The banks are hungry. The life insurance groups are hungry”.
A lengthy run of success in this asset class and paltry yields across the Treasury and corporate debt markets are seemingly a ZIRP-induced incentive to stick around for longer than prudent. As for ING itself, the Journal notes that the bank just reopened its real estate unit two years ago after shuttering it following the real estate collapse in 2008.
“Duration has never been this long in my career,” says Jeffrey Gundlach, chief executive of Los Angeles based DoubleLine Capital. “With rates near the lowest levels ever and duration at literally the highest level ever, it is the worst possible set-up versus history. You are [taking] more risk and getting less reward.”
- Philip Grant
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