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China Furious Over Rig Pictures: "What Japan Did Provokes Confrontation"

On Wednesday, we detailed China’s latest maritime dispute with a US ally. Just as the back-and-forth banter and incessant sabre-rattling over Beijing’s land reclamation activities in the Spratlys had died down, Washington and Manila passed the baton to Tokyo in the race to see who can prod the PLA into a naval confrontation first. 

To recap, Japan apparently believes that China is strategically positioning rigs as close to a geographical equidistance line as possible in order to siphon undersea gas from Japanese waters.

Here’s a map showing the position of the rigs and the line which divides the countries’ economic zones:

And here are the rigs themselves:

Tokyo’s position is that Beijing’s exploration activities violate a 2008 joint development agreement between the two countries. Beijing, on the other hand, "erroneously" believes it has the right to development gas fields located in its territorial waters.

As we noted yesterday, Chief Cabinet Secretary Yoshihide Suga’s assurance that the spat would not endanger the slow thaw of Sino-Japanese relations didn’t sound convincing under the circumstances:

The dispute won't do anything to help Sino-Japanese relations and although Suga claims the issue won't derail diplomatic progress, one has to imagine that Beijing has had just about enough of being told what it can and can't do in what it considers to be territorial waters. 

Sure enough, China has taken the rhetoric up a notch. Reuters has more:

Japan's release of pictures of Chinese construction activity in the East China Sea will only provoke confrontation between the two countries and do nothing for efforts to promote dialogue, China's Foreign Ministry said.


In a statement late on Wednesday, China's Foreign Ministry said it had every right to develop oil and gas resources in waters not in dispute that fall under its jurisdiction.


"What Japan did provokes confrontation between the two countries, and is not constructive at all to the management of the East China Sea situation and the improvement of bilateral relations," it said.

According to some accounts, China's O&G development efforts are tied to a long-running island dispute between the two countries. Here's Reuters again: 

In 2012, Japan's government angered Beijing by purchasing a disputed, uninhabited island chain in the East China Sea.


Until then, Beijing had curtailed activities under a pact with Japan to jointly develop undersea resources in disputed areas.


So, spiteful retailiation or legitimate exploration and development? We'll let readers decide with the help of the following color from BBC on the history behind the Senkaku islands row.

* *  *

From BBC

At the heart of the dispute are eight uninhabited islands and rocks in the East China Sea. They have a total area of about 7 sq km and lie north-east of Taiwan, east of the Chinese mainland and south-west of Japan's southern-most prefecture, Okinawa. The islands are controlled by Japan.


They matter because they are close to important shipping lanes, offer rich fishing grounds and lie near potential oil and gas reserves. They are also in a strategically significant position, amid rising competition between the US and China for military primacy in the Asia-Pacific region.



Japan says it surveyed the islands for 10 years in the 19th Century and determined that they were uninhabited. On 14 January 1895 Japan erected a sovereignty marker and formally incorporated the islands into Japanese territory.


After World War Two, Japan renounced claims to a number of territories and islands including Taiwan in the 1951 Treaty of San Francisco. These islands, however, came under US trusteeship and were returned to Japan in 1971 under the Okinawa reversion deal.


Japan says China raised no objections to the San Francisco deal. And it says that it is only since the 1970s, when the issue of oil resources in the area emerged, that Chinese and Taiwanese authorities began pressing their claims.


China says that the islands have been part of its territory since ancient times, serving as important fishing grounds administered by the province of Taiwan.

Hoisington On Bond Market Misperceptions: "Secular Low In Treasury Yields Still To Come"

Submitted by Hoisington Investment Management's Lacy Hunt via,

Misperceptions Create Significant Bond Market Value

From the cyclical monthly high in interest rates in the 1990-91 recession through June of this year, the 30-year Treasury bond yield has dropped from 9% to 3%. This massive decline in long rates was hardly smooth with nine significant backups. In these nine cases yields rose an average of 127 basis points, with the range from about 200 basis points to 60 basis points (Chart 1). The recent move from the monthly low in February has been modest by comparison. Importantly, this powerful 6 percentage point downward move in long-term Treasury rates was nearly identical to the decline in the rate of inflation as measured by the monthly year-over-year change in the Consumer Price Index which moved from just over 6% in 1990 to 0% today. Therefore, it was the backdrop of shifting inflationary circumstances that once again determined the trend in long-term Treasury bond yields.

In almost all cases, including the most recent rise, the intermittent change in psychology that drove interest rates higher in the short run, occurred despite weakening inflation. There was, however, always a strong sentiment that the rise marked the end of the bull market, and a major trend reversal was taking place. This is also the case today.

Presently, four misperceptions have pushed Treasury bond yields to levels that represent significant value for long-term investors. These are:

  1. The recent downturn in economic activity will give way to improving conditions and even higher bond yields.
  2. Intensifying cost pressures will lead to higher inflation/yields.
  3. The inevitable normalization of the Federal Funds rate will work its way up along the yield curve causing long rates to rise.
  4. The bond market is in a bubble, and like all manias, it will eventually burst.
Rebounding Economy and Higher Yields

The most widely held view of these four misperceptions is that the poor performance of the U.S. economy thus far in 2015 is due to transitory factors. As those conditions fade, the economy will strengthen, sparking inflation and causing bond yields to move even higher. The premise is not compelling, as there is solid evidence of a persistent shift towards lower growth. Industrial output is expected to decline more in the second quarter than the first. This will be the only back-to-back decrease in industrial production since the recession ended in 2009 (Chart 2). Any significant economic acceleration is doubtful without participation from the economy’s highest value-added sector. To be sure, the economy recorded higher growth in the second quarter, but that was an easy comparison after nominal and real GDP both contracted in the first quarter.

Adding to a weak manufacturing sector, other fundamentals continue to indicate that top- line growth will not accelerate further this year, and inflation will be contained. M2 year-over-year growth has slipped below the growth rates that prevailed at year-end. The turnover of that stock of money, or velocity, is showing a sharp deceleration. Presently M2 velocity is declining at a 3.5% annual rate, and there are signs that it may decline even faster. If growth in M2 or velocity subsides much further, then nominal GDP growth is unlikely to reach the Fed’s recently revised forecast of 2.6% this year (M*V=Nominal GDP).

At year-end 2014 the Fed was forecasting nominal GDP growth to accelerate to 4.1% this year, compared with 3.7% and 4.6% actual increases in 2014 and 2013, respectively. In six months the Fed has once again been forced to admit it's error and has massively lowered its forecast of nominal growth to 2.6%. Additionally, the Fed formerly expected a 2.8% increase in real GDP and now anticipates only a 1.9% increase in 2015, down from 2.4% and 3.1% in 2014 and 2013, respectively. The inflation rate forecast was also lowered by 60 basis points.

Transitory increases in long Treasury bond yields are not likely to be sustained in an environment of a pronounced downward trend in growth in both real and nominal GDP. However the expectation of lower long rates is also bolstered by the well-vetted economic theory of “the Wicksell effect” (Knut Wicksell 1851-1926).

Wicksell suggested that when the market rate of interest exceeds the natural rate of interest funds are drained from income and spending to pay the financial obligations of debtors. Contrarily, these same monetary conditions support economic growth when the market rate of interest is below the natural rate of interest as funds flow from financial obligations into spending and income. The market rate of interest and the natural rate of interest must be very broad in order to capture the activities of all market participants. The Baa corporate bond yield, which is a proxy for a middle range borrowing risk, serves the purpose of reflecting the overall market rate of interest. The natural rate of interest can be captured by the broadest of all economic indicators, the growth rate of nominal GDP.

In comparing these key rates it is evident that the Wicksell effect has become more of a constraint on growth this year. For instance, the Baa corporate bond yield averaged about 4.9% in the second quarter. This is a full 230 basis points greater than the gain in nominal GDP expected by the Fed for 2015. By comparison, the Baa yield was only 70 basis points above the year-over-year percent increase in nominal GDP in the first quarter.

To explain the adverse impact on the economy today of a 4.8% Baa rate verses a nominal GDP growth rate of 2.6% consider a $1 million investment financed by an equal amount of debt. The investment provides income of $26,000 a year (growth rate of nominal GDP), but the debt servicing (i.e. the interest on Baa credit) is $48,000. This amounts to a drain of $22,000 per million. Historically the $1 million investment would, on average, add $2,500 to the annual income spending stream. Over the past eight decades, the Wicksell spread averaged a negative 25 basis points (Chart 3).

Since 2007 however, the market rate of interest has been persistently above the natural rate, and we have experienced an extended period of subpar economic performance. Also, during these eight years the economy has been overloaded with debt as a percent of GDP and, unfortunately, too much of the wrong type of debt. The ratio of public and private debt moved even higher over the past six months suggesting that the Wicksell effect is likely to continue enfeebling monetary policy and restraining economic growth and inflation.

Cost Push Inflation Means Higher Yields

The second misperception is more subtle. The suggestion is that higher health care and/or wage costs will force inflation higher. It follows, therefore, that Treasury bond yields will rise as they are heavily influenced by inflationary expectations and conditions. Further, this higher inflation will cause the Fed to boost the federal funds rate.

Some argue that health care insurance costs are projected to rise very sharply, with some companies indicating that premiums will need to rise more than 50% due to the Affordable Care Act. Even excluding the extreme increases in medical insurance costs, many major carriers have announced increases of 20% or more. Others argue that the six-year low in the unemployment rate will cause wage rates to accelerate.

Four considerations cast doubt on these cost- push arguments. First, increases in costs for medical care, which has inelastic demand, force consumers to cut expenditures on discretionary goods with price elastic demand. Goods with inelastic demand do not have many substitutes while those with elastic demand have many substitutes. When an economy is experiencing limited top-line growth, as it is currently, the need to make substitute-spending preferences is particularly acute. Thus, discretionary consumer prices are likely to be forced lower to accommodate higher non-discretionary costs, leaving overall inflation largely unchanged.

Second, alternative labor market measures indicate substantial slack remains and evidence is unconvincing that wage rates are currently rising to any significant degree. The U.S. Government Accountability Office (GAO) released a report that looks at the “contingent workforce” (Wall Street Journal, May 28, 2015). These are workers who are not full-time permanent employees. In the broadest sense, the GAO found these workers accounted for 40.4% of the workforce in 2010, up from 35.3% in 2006. The GAO found that this growth mainly results from an increase in permanent part-timers, a category that grew as employers reduced hours and hired fewer full-time workers. The GAO also said that the actual pay earned was nearly 50% less for a contingent worker than a person with a steady full time job. The process portrayed in the study undermines the validity of the unemployment rate as an indicator because a person is counted as employed if they work as little as one hour a month. Additionally there is an upward bias on average hourly earnings due to the difference in hours worked between full-time and contingent workers.

Third, corporate profits and closely aligned productivity measures are more consistent with declining, rather than strengthening, wage increases. After peaking in the third quarter of 2013, profits after tax and adjusted for inventory gains/losses and over/under depreciation have fallen by 16% (Chart 4). Over the past four years, nonfarm business productivity increased at a mere 0.6% annual rate, the slowest pace since the early 1980s. A significant wage increase would cut substantially into already thin profits as top-line growth is decelerating, and the dollar hovers close to a 12.5 year high. Together the profits and productivity suggest that firms need to streamline operations, which would entail reducing, rather than expanding, employment costs.

Fourth, experience indicates inflationary cycles do not start with rising cost pressures. Historically, inflationary cycles are characterized by “a money, price and wage spiral” and in that order. In other words, money growth must accelerate without an offsetting decline in the velocity of money. When this happens, aggregate demand pulls prices higher, which, in turn, leads to faster wage gains. The upturn leads to a spiral when the higher prices and wages are reinforced by another even faster growth in money not thwarted by velocity. Current trends in money and velocity are not consistent with this pattern and neither are prices and wages.

Normalizing the Federal Funds Rate

A third argument is that the Fed needs to normalize rates, and as they do this, yields will also rise along the curve. It is argued the Fed has held the federal funds rate at the zero bound for a long time with results that are questionable, if not detrimental, to economic growth. Proponents for this argue that the zero bound may have resulted in excessive speculation in stocks and other assets. This excess liquidity undoubtedly boosted returns in the stock market, but the impact on economic activity was not meaningful. At the same time, the zero bound and the three rounds of quantitative easing reduced income to middle and lower range households who hold the bulk of their investments in the fixed income markets. Thus, to reverse the Fed’s inadvertent widening of the income and wealth divide, the economy will function better with the federal funds rate in a more normal range. Also, by raising short-term rates now, the Fed will have room to lower them later if t he economy worsens.

Normalization of the federal funds rate is widely accepted as a worthwhile objective. However, achieving normalization is not without its costs. In order to increase the federal funds rate, the Fed will raise the interest rate on excess reserves of the depository institutions (IOER). Also, the Fed will have to shrink the $2.5 trillion of excess reserves owned by the depository institutions by conducting reverse repurchase agreements. This is in addition to operations needed to accommodate shifts in excess reserves caused by fluctuations in operating factors, such as currency needs of the non- bank public, U.S. Treasury deposits at the Fed and Federal Reserve float. If increases in the IOER do not work effectively, the Fed will then need to sell outright from its portfolio of government securities, causing an even more significant impact out the yield curve. The Fed’s portfolio has close to a seven-year average maturity.

A higher federal funds rate and reduced monetary base would place additional downward pressure on both money growth and velocity, serving to slow economic activity. Productivity of debt has a far more important influence on money velocity than interest rates. Nevertheless, higher interest rates would cause households and businesses to save more and spend less, which, in turn, would work to lower money velocity. Such a policy consequence is highly unwelcome since velocity fell to a six decade low in the first quarter and another drop clearly appears to have occurred in the second quarter.

These various aspects of the Fed’s actions would, all other things being equal, serve to reduce liquidity to the commodity, stock and foreign exchange markets while either placing upward pressure on interest rates or making them higher than otherwise would be the case. Stock prices and commodity prices would be lower than they otherwise. In addition the dollar would be higher than otherwise would be the case deepening the deficit between imports and exports of goods and services.

Increases in the federal funds rate would be negative for economic activity. As the Fed’s restraining actions become apparent, however, the Fed could easily be forced to lower the federal funds rate, making increases in market interest rates temporary.

The predicament the Fed is in is one that could be anticipated based on the work of the late Robert K. Merton (1910-2003). Considered by many to be the father of modern day sociology, he was awarded the National Medal of Science in 1994 and authored many outstanding books and articles. He is best known for popularizing, if not coining, the term “unanticipated consequences” in a 1936 article. He also developed the “theory of the middle range”, which says undertaking a completely new policy should proceed in small steps in case significant unintended problems arise. As the Fed’s grand scale experimental policies illustrate, anticipating unintended consequences of untested policies is an impossible task. For that reason policy should be limited to conventional methods with known outcomes or by untested operations only when taken in small and easily reversible increments.

Bond Market Bubble

The final argument contends that the Treasury bond market is in a bubble, and like all manias, it will burst at some point. In The New Palgrave, Charles Kindleberger defined a bubble up as ..." a sharp rise in the price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers". The aforementioned new buyers are more interested in profits from “trading the asset than its use or earnings capacity”. For Kindleberger the high and growing price is unjustified by fundamental considerations. In addition Kindelberger felt that the price gains were fed by ‘momentum’ investors who buy, usually with borrowed funds, for the sole purpose of selling to others at a higher price. For Kindleberger, a large discrepancy between the fundamental price and the market price reflected excessive debt increases. This condition is referred to as “overtrading”. At some point, perhaps after a prolonged period of time, astute investors will begin to recognize the gap between market and fundamental value. They will begin to sell assets financed by debt, or their creditors may see this gap and deny the speculators credit. Charles Kindleberger called this process “discredit”. For Kindleberger, the word discredit was designed to capture the process of removing some of the excess debt creation. The phase leads into the popping of the bubble and is called “revulsion”.

The issue in determining whether or not a bubble exists is to determine what constitutes fundamental value. For stocks this is generally considered to be after-tax earnings, cash flow or some combination of the two and the discount rate to put these flows in present value terms. Most experts who have addressed this issue of economic fundamentals have confined their analysis to assets like stocks or real estate. In the Palgrave article Kindelberger did not specifically cover the case of bonds. We could not find discussions by well- recognized scholars that explicitly defined a Treasury bond value or a market bubble. The reason is that there is no need.

To be consistent with well-established and thoroughly vetted theory, the economic value of long-term Treasury bonds is determined by the relationship between the nominal yield and inflationary expectations, or the real yield. To assess the existence of a Treasury bond bubble one must evaluate the existing real yield in relation to the historic pattern of real yields. If the current real yield is well above the long-term historic mean then the Treasury bond market is not in a bubble. However, if the current real yield is significantly below this mean, then the market is in a bubble. By this standard, the thirty-year Treasury bond is far from a bubble. In the past 145 years, the real long bond yield averaged 2.1%. At a recent nominal yield of 3.1% with a year over year increase in inflation of 0.1%, the real yield stands at 3%, 50% greater value than investors have, on average, earned over the past 145 years. Indeed, the real yield is virtually the same as in 1990 when the nominal bond yield was 9%. Contrary to the Treasury bond market being in a bubble, errant concerns about inflation or other matters have created significant value for this asset class.


In summary, economic theory and history do not suggest the secular low in inflation, or that its alter ego, Treasury bond yields, is at hand. The excessive debt burden, slow money growth, declining money velocity, the Wicksell effect and the high real rate of interest indicate that the fundamental elements are exerting downward, rather than upward, pressure on inflation. Inflation will not trough as long as the US economy continues to become even more indebted. While Treasury bond yields have repeatedly shown the ability to rise in response to a multitude of short-run concerns that fade in and out of the bond market on a regular basis, the secular low in Treasury bond yields is not likely to occur until inflation troughs and real yields are well below long-run mean values. We therefore continue to comfortably hold our long-held position in long-term Treasury securities.

15 Years After Land-Grabs, Mugabe Invites White Farmers Back To Zimbabwe

File this one away in the "when populism backfires" folder. 

A little over a month after announcing that the Zimbabwean dollar - which, you’re reminded, was phased out in 2009 after inflation rose modestly to 500 billion percent - would be demonetized and exchanged at a generous rate of $5 for every 175 quadrillion, Zimbabwe will for the first time rethink the sweeping land grabs which began in 2000 and subsequently crippled the country’s economy.

Many Zimbabwean farmers who have stopped growing food in favor of "green gold" (tobacco) fear they will starve this winter after a severe drought and a generalized "lack of knowledge" left them with a subpar crop that fetched little at auction. Here’s more from Rueters

Thousands of small-scale farmers in Zimbabwe fear they will be going hungry this winter after abandoning traditional staples like maize, sorghum and groundnuts for tobacco, a cash crop known locally in this southern African nation as "green gold".


For 15 years after Zimbabwe's agriculture sector collapsed in the face of President Robert Mugabe's seizure of white-owned farms to resettle landless blacks, the tobacco industry has been booming, with farmers funded by private firms to grow tobacco.


But this switch, coupled with the worst regional drought in nearly a decade, has left Zimbabwe in a precarious food situation. Many farmers have complained of low prices as the season ends while buyers argue the quality of the crop was poor.



The tobacco industry has become the country's biggest export earner with over 88,000 growers registered with the tobacco regulatory body, the Tobacco Industry and Marketing Board, in the 2014/15 season, up from 52,000 in 2012.


But the returns are often uncertain and many farmers have been left disappointed.


Industry figures showed that at the end of the selling season this month farmers sold 188.5 million kgs worth $555 million, down 8.5 percent from a year ago when the crop was worth $654 million.


"It was a disaster," said David Muyambo, 35, a father of four, who earned $74 from tobacco sales this season after investing $1,200 in his crop. "I need to buy food for my family and I have no money."


Muyambo blames his failure on erratic rains, which decimated his crop, as well as his lack of knowledge on how to apply fertilizer, remove suckers and cure the crop.


Muyambo said he will never farm tobacco again.


With more farmers focused on tobacco, Zimbabwe's harvest of maize, a staple food, dropped by 49 percent in the 2014/15 season, the government said, which is set to exacerbate food shortages in Zimbabwe, once the bread-basket of the region.

Against this rather dreary backdrop, the government is beginning to reconsider its stance towards white farmers and will, according to The Telegraph, "give official permission for some whites to stay on their land."

Via The Telegraph:

Zimbabwe’s government has for the first time suggested it may give official permission for some white farmers to stay on their land, 15 years after it sanctioned widespread land grabs that plummeted the country into an economic crisis.


Douglas Mombeshora, the Zanu-PF Lands Minister, said provincial leaders had been asked to draw up a list of white farmers they wanted to stay on their farms deemed to be “of strategic economic importance”.


“We have asked provinces to give us the names of white farmers they want to remain on farms so that we can give them security of tenure documents to enable them to plan their operations properly,” Mr Mombeshora said. 


More than 4,000 white farmers lost their land after Mr Mugabe lost a referendum to the new Movement for Democratic Change party and, in a bid to regain popularity, authorised land grabs by disaffected war veterans.


Today, fewer than 300 white farmers remain on portions of their original land holdings in Zimbabwe and many of the seized farms lie fallow, meaning the former Breadbasket of Africa has to import food to feed its population.


Among remaining farmers who have been recommended for a reprieve of Mr Mugabe’s edict that whites can no longer own land in Zimbabwe is Elizabeth Mitchell, a poultry farmer who produces 100,000 day-old chicks each week. 



And so once again we see that necessity (a food shortage) breeds invention (rethinking populist land grabs), but lest anyone should believe that Mugabe has done a complete 180, we'll close with the following advice given to supporters at a recent Patriotic Front rally:

"Don't be too kind to white farmers. They can own industries and companies, or stay in apartments in our towns but they cannot own land. They must leave the land to blacks.” 

The Hard Truth: For Retail Investors, The NYSE Is Always Out Of Service

Submitted by Nanex,

1. Charts of the Event.

On July 8, 2015 at 11:32:57, trades and quotes stopped updating from the NYSE. Trading eventually resumed at 3:10pm.

Timeline up to the halt.

Trades from NY-ARCA (red) and NYSE (blue) when NYSE halted (note the disappearance of the blue dots).

NYSE trades when NYSE halted. (This is the chart Stephen Colbert used on the The Late Show)

NYSE trades when NYSE resumed.


2. Does the NYSE matter? The Importance of NYSE's Quote.

On a typical trading day, quotes from the NYSE set the NBBO (National Best Bid/Offer) more than 60% of the time - beating out 10 other exchanges. You would think that losing NYSE's quote would severely impact the Retail Investor's trading experience.

Below is the same chart as above but on the day of the NYSE halt. Right at the open we can see there's a problem. Then NYSE's quote disappears, mostly replaced by Nasdaq.

There is also this excellent study of how trades fared among different exchanges, which is worth reading. What they found: the NYSE has great executions compared to other exchanges.


3. The Halt's Impact on Retail Investors: Experts and Spin.

"Even though the NYSE floor is down, the NYSE Arca exchange is still operating.
A retail investor who wants to trade Exxon will see no impact from the outage.

James Angel, Georgetown business school finance professor to Business Insider

The article below is representative of how most main stream news media were spinning the NYSE halt story: Retail was having a rough day! It's hard to fault them, given how important NYSE's quote is for NYSE stocks.

Later in the day, when no evidence surfaced of Retail Investors having trouble, a few began questioning the news spin.

When it was clear that Retail Investors weren't impacted, the search was on for what was behind the miracle "success story".

Without any evidence or a basic understand of retail order execution, some went so far as to claim stock market fragmentation saved the day. (We think Pisani got it dead wrong).

Naturally, Modern Markets, the High Frequency Trading (HFT) Lobbyist, was quick to claim another benefit of HFT!
They saved the day! Naturally. For a good look at how far lobbyists will go to spin a story (and probably more disturbing, how far a major network will let them), please watch this short video.


4. The Hard Truth: To Retail Investors, the NYSE is Always Dark.

A few of those who really understood where retail stock orders execute spoke the truth:

But wait a minute, can Chris Nagy be right? After all, we know that the NYSE sets the best prices more than 60% of the time. Without NYSE's best prices, there had to be some harm, right?

Retail orders execute on the NYSE, right?

Well, in a word: NO.

What the news media conveniently (or intentionally) forgot to ask and investigate:

What really happens to the Retail Investor order?

Answering part of that question is a simple matter of searching SEC required 606 reports from each retail broker.

The following list is by no means complete. For brokers not listed, simply Google "BrokerName 606 Report".

Here's what we found:

1. Schwab Doesn't Route to NYSE

2. Vanguard Brokerage Doesn't Route to NYSE

3. E*Trade Doesn't Route to NYSE

4. Fidelity Retail Brokerage Doesn't Route to NYSE

5. Scottrade Doesn't Route to NYSE

6. Credit Suisse (Private Client Services no less) Doesn't Route to NYSE (or anywhere else!)

7. Morgan Stanley Wealth Management Doesn't Route to NYSE

8. Edward Jones Doesn't Route to NYSE

9. Northern Trust Doesn't Route to NYSE

10. Wells Fargo Doesn't Route to NYSE

11. Lightspeed Doesn't Route to NYSE

12. TradeKing Doesn't Route to NYSE

13. Citigroup Doesn't Route to NYSE (Note: Citi isn't retail, but as they own ATD we found this very interesting)

Now you know why Retail Investors didn't have a problem with the NYSE being out of service - retail orders rarely route to the NYSE.

For Retail Investors, the NYSE is ALWAYS OUT OF SERVICE.

Which leads to the inevitable question..


5. Where Do Retail Investor Orders Go?

The simple answer: to the highest contracted bidder. Stock "wholesalers" or internalizers like Citadel or Knight pay retail brokers lots of cash to execute retail trades, essentially creating a "third market". Why? Because in a high frequency trading world, where stock prices have never been more fuzzy to the end user, but crystal clear to those that spend enormous sums on colocation and PhD employees, it's never been easier to print money (not unlike Bernie Madoff's scheme in the 90's). But that is the subject of a much, much longer story. Someone should write a book.

In the meantime, we strongly encourage you to read this fabulous guide, written by an industry insider. This guide shines much needed light on how Wall Street treats (games) each type of Retail Investor order.

US Recession Imminent - World Trade Slumps By Most Since Financial Crisis

As goes the world, so goes America (according to 30 years of historical data), and so when world trade volumes drop over 2% (the biggest drop since 2009) in the last six months to the weakest since June 2014, the "US recession imminent" canary in the coalmine is drawing her last breath...



As Wolf Street's Wolf Richter adds, this isn’t stagnation or sluggish growth. This is the steepest and longest decline in world trade since the Financial Crisis. Unless a miracle happened in June, and miracles are becoming exceedingly scarce in this sector, world trade will have experienced its first back-to-back quarterly contraction since 2009.

Both of the measures above track import and export volumes. As volumes have been skidding, new shipping capacity has been bursting on the scene in what has become a brutal fight for market share [read… Container Carriers Wage Price War to Form Global Shipping Oligopoly].

Hence pricing per unit, in US dollars, has plunged 14% since May 2014, and nearly 20% since the peak in March 2011. For the months of March, April, and May, the unit price index has hit levels not seen since mid-2009.

World trade isn’t down for just one month, or just one region. It wasn’t bad weather or an election somewhere or whatever. The swoon has now lasted five months. In addition, the CPB decorated its report with sharp downward revisions of the prior months. And it isn’t limited to just one region. The report explains:

The decline was widespread, import and export volumes decreasing in most regions and countries, both advanced and emerging. Import and export growth turned heavily negative in Japan. Among emerging economies, Central and Eastern Europe was one of the worst performers.

Given these trends, the crummy performance of our heavily internationalized revenue-challenged corporate heroes is starting to make sense: it’s tough out there.

But not just in the rest of the world. At first we thought it might have been a blip, a short-term thing. Read… Americans’ Economic Confidence Gets Whacked

What's The Real Reason The Fed Is Raising Rates? (Hint: It's Not Employment)

Submitted by Roger Thomas via,

Sometime this fall, the Federal Reserve will begin a new tightening cycle.

Publicly, Federal Reserve officials appear to be confident that the American labor market may be overheating or that inflation may be on the way in.

Is this the case?

In looking at Employment, Industrial Production, Consumer Prices, Capacity Utilization, Retail Sales, and the West Texas Intermediate price of oil, there's no evidence that the Fed should raise rates.

What is the Fed worried about?

Probably, and almost exclusively, it's financial asset price appreciation.

Here's a review.


A picture of employment growth against the Federal Reserve's target interest rate follows.  Interestingly, in past tightening cycles, employment growth was either accelerating or flat.

That's not the case this time around.  Employment growth is decelerating, and has been decelerating since February 2015.

Industrial Production

A very similar story to Employment is present in the Industrial Production picture.  Except for one instance, Industrial Production growth is either accelerating or flat when the Fed raises rates.

That's not the case this time around.

Consumer Prices

Here's the Consumer Price picture.

As with employment, the Fed almost always raises rates when inflation is accelerating.

That's not the case this time.

Capacity Utilization

Capacity Utilization has a very similar story to Industrial Production.

Price of Oil

Here's the oil price picture.

A less interesting story emerges here, probably because, of the indicators mentioned here, oil is of least policy value.

Retail Sales


As with the other economic indicators already mentioned, a tightening cycle this fall would be quite odd when looking at Retail Sales growth.


Summing Up the Non-Causes

As indicated, it's probably not the real economy behind the Fed's thinking.

*  *  *

Here's what's really concerning Fed officials.

Equity Values

It's equity values that has the Fed concerned.

The Fed sees it's ultra-low monetary policy as having been incredibly stimulative to financial assets.  And, they don't want another technology bubble.

So, to avoid a technology bubble, now's the time to start raising rates.

Since the last time the Fed started a tightening cycle, the S&P 500 is up 62%, about where the mid-90s experience of 63% was.  It's well short of the +191% in the late90s/early 2000s equity markets produced.  It's also better than the -21% experienced in the mid-2000s.

Interestingly, the P/E ratio confirms a similar story.

In looking at the Shiller P/E ratio, perhaps a better rule than the Taylor rule to predict Fed tightening moves today is the P/E ratio rather than inflation and unemployment.  Just think about it.

It's an interesting experiment for the Fed this time around, being concerned about the financial economy more than the real economy.

Fed Conclusion

Overall, although Federal Reserve officials publicly claim that the reason for impending rate hikes is that the American economy is doing well, there's not a lot of evidence, at least based upon prior tightening cycles, that it's the real economy the Fed is worried about.

Rather, the pending beginning of the Fed's rate hiking season likely stems almost exclusively from concern about financial markets.

Perhaps unsurprisingly, the Fed doesn't want another technology-type bubble (interesting that the Fed thinks it knows the intrinsic value of stocks better than the market).  At least, that's what the data appear to suggest.

A Stunning Look At California's Historic Drought - From The Air

"Ugly brown rings where waves used to lap at the shore. Dry docks lying on desiccated silt. Barren boat ramps. Trickles of water." Those are just some of the disturbing images California's Department of Water Resources team saw in an aerial tour of Northern California's Folsom Lake, Lake Oroville and Shasta reservoirs released this week...


The dramatic aerial views timelapsed from just a year ago show the level of devastation already... and it's not about to get any better...


Click image below for interactive gallery...



Amazon Just Became Bigger Than Walmart: Here's Why

MThe moment everyone has been waiting for has finally arrived, by which of course, we mean the moment when the market cap of AMZN would finally surpass Wal-mart.

Just after 4pm Jeff Bezos' Amazon reported number that were quite impressive at first blush. And at second blush as well. Among these: a whopping blow out beat on the topline of $23.2 billion in revenue, an increase of 27% from a year ago, and far above the $22.4 billion expected, which in turn resulted in Net income of $92 million, or EPS of $0.19. The street was expecting a loss of $0.14 per share.

In terms of where the bulk of the growth and profitability came from, one word, or rather three letters: AWS (Amazon Web Services), also known as the "cloud", whose net sales soared by 81% Y/Y to $1.8 billion generating a 21.4% operating margin and net income of $391 million up from $77 million a year ago.

And while the quarter was good especially for AMZN the "web services" company, it was AMZN's forecast for the future that was even more impressive: 

The company now expects net sales to be between $23.3 billion and $25.5 billion, or to grow between 13% and 24% compared with third quarter 2014.  It also expects operating income (loss) is expected to be between $(480) million and $70 million, compared to $(544) million in third quarter 2014, although if the current quarter is any indicatiton this is some rather serious sandbagging.

But words aside: here, in three charts is what happened, with the company that now employs a record 183,000 people:

Worldwide net sales vs total Employees:


Q2 operating and net income in context. Clearly the quarter was an outlier - the only question is why and how?


And finally LTM Free Cash Flow. It appears Bezos does indeed have quite a bit FCF leverage if and when he wants it.


Again our question: why convert AMZN from a growth to a free cash flow model now: the last time the company tried this it ended up being quite disappointed.

For now, however, the algos love it, the shorts hate it and are scrambling to cover, and the result is an AMZN whose market cap has just jumped by over $40 billion to a record $268 billion.

And, yes, It is now far bigger than Walmart.

Commodity Carnage Contagion Crushes Stocks & Bond Yields

Summing up Mainstream media today...


Where to start...

Bonds - Good!


Stocks - Bad!


Commodities - Ugly!

*  *  *

Everything was red in equity index land today... Trannies worst day since January


Stocks are all red for the week... Dow is down over 400 points from Monday's highs back below its 200DMA; S&P 500 cash is back below its 50DMA; and Russell 2000 broke below its 50 & 100DMA


Financials have given up their earlier week gains (as rates flatten) and only builders remain green on the week...


Leaving The Dow red for 2015...


52-Week Lows are at their highest since 2014...


On the week, the Treasury complex is seeing major flattening as the long-end collapses while short-end lifts on rate hike expectations...


With 30Y retracing all "Greece is fixed" weakness...


With 2s30s near 3 month flats...


Maybe all that NIM hope is overprices after all...


The US Dollar leaked lower on the day as EUR strengthened and cable weakened...


But that did nothing to support commodities...


Copper now at 6 year lows


And front-month crude getting close to cycle lows...


Charts: Bloomberg

Bonus Chart: Protection costs are dramatically diverging between credit and stocks...

As Bloomberg notes, the last time the VIX diverged from high-yield CDS this much was in August 2013, when investors were anticipating the Federal Reserve would start reducing its quantitative easing program. The equity volatility gauge jumped more than 70 percent in the next two months as the S&P 500 lost as much as 4.6 percent.


Bonus Bonus Chart: The real fear index is the most complacent since before Lehman... (details on Implied Correlation here)

Is The Echo Housing Bubble About To Burst?

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Echo bubbles aren't followed by a third bubble.

Speculative bubbles that burst are often followed by an echo bubble, as many participants continue to believe that the crash was only a temporary setback.

The U.S. housing market is experiencing a classic echo bubble. Exhibit A is the Case-Shiller Housing Index for the San Francisco region, which has surged back to levels reached at the top of the first bubble:

Exhibit B is the Case-Shiller 20 City Housing Index, which has notched a classic Fibonacci 62% retrace of the first bubble's decline.

Several things pop out of the Case-Shiller San Francisco chart. One is the symmetry of the two stages of the initial housing bubble: the first leg rose 80% from 1997 to 2001, and the second leg also rose about 80% from 2003 to 2007.

There is also a time symmetry, as each leg took about five years.

The echo bubble has now inflated for roughly the same time period, and has almost fully retraced the 45% decline from the 2007 peak. Though recent buyers may hope this bubble will be different from all previous bubbles (i.e. it will never pop), history suggests the echo bubble will be fully retraced in a sharp decline lasting about two to three years, in rough symmetry with the collapse of the first housing bubble 2008-2010.

The broader 20-city Case-Shiller Index reflects the same time symmetry: the echo bubble and the initial housing bubble both took about the same length of time to reach their zenith. Once again, we can anticipate a symmetrical decline that roughly parallels the 33% drop from 2007 to 2009.

There is one key difference between the first bubble and the echo bubble: echo bubbles aren't followed by a third bubble. Markets often give second-chances, but they rarely offer third-chances.

Turkey Permits U.S. To Use Its Airbase For Air Strikes Against Syria

Earlier we reported that in an apparent retaliation against Monday's alleged suicide bombing and today's follow up killing of a Turkish soldier on the border with Syria, the Turkish army launched what under normal conditions would be deemed a land invasion of Turkey when four of its tanks entered Syrian territory. Rhetorically, we asked in "one may wonder if NATO-member Turkey's land invasion of Syria, which many have said was long overdue following months of rhetoric and belligerent posturing, under the pretext of ISIS "liberation", has just begun."

A following report from the WSJ largely answers our question: citing unnamed defense officials, WSJ reports that after months of negotiations, "Turkey has agreed to let the U.S. military carry out airstrikes against Islamic State fighters from a U.S. air base near the Syrian border."

This is the same authoritarian president who has repeatedly cracked down against protesters using various less than media friendly means, and one whom Obama has lashed out at diplomatically. It appears that when pursuing grander visions, Obama is will to forgive anyone's humanitarian record, or lack thereof, and do anything to achieve America's real politik ambitions. 

Like in this case: the deal, agreed to by President Barack Obama and Turkish President Recep Tayyip Erdogan, will allow the U.S. to use Incirlik Air Base in eastern Turkey to send manned and unmanned planes to attack Islamic State fighters, the officials said. The two leaders spoke on Wednesday, the White House said.

Use of Incirlik is part of a broader deal between the U.S. and Turkey to deepen their cooperation in the fight against Islamic State that is growing increasingly perilous for Turkey.


On Thursday, Islamic State forces in Syria and the Turkish military engaged in a deadly cross-border battle that left at least one Turkish officer dead.


“They’re in a counter-ISIL fight right across the border,” said one defense official, using one of the acronyms for Islamic State, which is also known as ISIS.

And with that the northern wing of the anti-Syria, pardon anti-ISIS campaign is complete, with the US covering air sorties while Turkey will use NATO tanks to secure the ground and slowly but surely, together with the eastern front where the US will soon deplay troops, close in on Damascus to eliminate the biggest Syrian ISIS threat of them all: president Assad and his (and the Kremlin's) stern anti-Qatar pipeline position.

The Hunt For The "Mystery" Gold "Bear Raid" Leader Begins

In the immediate aftermath of Sunday night's massive gold slam, which was oddly reminiscent of the great silver crash of 2011 when on May 1 just around 6:25pm, silver plunged by 15%, from $48 to $42 with no news or catalyst...


... marking the all time high price of silver in the current precious metals cycle (that particular 'malicious seller' has never been identified) the promptly arranged narrative was that because the gold crash took place in the span of 30 seconds just before Chinese stocks opened and broke the gold futures market not once but twice, that it has to be a China-based seller with Reuters taking the lead and quickly pointing the finger with an article titled "Gold hits five-year low, under $1,100 on Chinese selling."

Ironically, the very same Reuters last night admitted that it had been wrong and that it was in fact: "New York sell orders in thin trade" that triggered the "Shanghai gold rout":

In early Asian trading hours on Monday, when typically only tens of contracts of gold are traded, investors dumped more than $500 million worth of bullion in New York in four seconds, triggering the market's biggest rout in years.


The sell-off began when one or more massive sell orders hit the price of gold on the CME Group's Comex futures in New York a tenth of a second after 9:29 a.m. in Shanghai, triggering turnover of almost 5,000 lots of gold in a blink of an eye. That equates to 13 tonnes of gold, more than typically trades in hours during this time of day, and the selling knocked the price almost $20 to $1,100 per ounce during those four seconds. It marked the first leg of a dramatic 60-second sell-off that saw prices sink more than 4 percent to five-year lows.

And just like that the narrative shifts again: instead of a Chinese seller, the real culprit appears to have been a US-based entity masking as a Chinese trader, around which the media then conveniently built a further goal-seeked "story" in which the Sunday night selling (by a US entity now) was the result of a PBOC announcement that its gold holdings had risen to "only" 1600 tons... however the problem is that all this had been known since Friday morning.

So, fast forward to this morning when in yet another Reuters piece, we "find" that the narrative has shifted once more and that now, "traders from Hong Kong to New York are pointing the finger at others for being behind the move while struggling to unmask the mystery sellers."

In other words: the "hunt" for the great gold "bear raid leader" has begun.

Singapore-based futures brokerage Phillip Futures declared "indiscriminate selling by Asian hedge funds at the stroke of the market's open in Shanghai" as the chief cause of the price fall in a letter to clients.


But the most well known Chinese funds denied involvement, and as futures trading is anonymous, dealers may never know who was buying and selling during those crucial seconds.


Such details often only become available if regulators take action, and amid the regulatory scrutiny following China's recent equity market tumbles, it's unlikely any trader or fund will be eager to take credit for setting off another avalanche.


The fact that the selloff occurred while Japan's markets were closed for a holiday and U.S. and European traders remained on weekend leave served to implicate China-based dealers in the eyes of some market participants.

At this point a Reuters source even dared to use the "M" word:

"That move was aggressive manipulation. Somebody clearly wanted the market lower and timed it very well," said a gold trader at a bank in Hong Kong, who saw parallels with the way funds have been linked to swings in copper.

Of course it was, but instead of focusing on what truly matters let's go chasing for red, literally, herrings...

Chinese funds such as Shanghai Chaos Investment Co and Zhejiang Dunhe Investment Co were, according to traders, behind falls in copper, one in March last year when the metal fell more than 8 percent in three days, and again in January this year when copper slid almost 8 percent in two days.

... herrings which however had nothing to do with the actual selling:

Sources familiar with both Zhejiang Dunhe and Chaos, and at similar outfits, say that while China's status as the dominant copper consumer left that market vulnerable to potential influence, China's traders have no such sway over bullion.


"Honestly, Chinese hedge funds are not as experienced as the overseas veterans and gold is more connected to U.S. dollar movement and well-dominated by Wall Street," said a trader with a Shanghai hedge fund.

Then, inexplicably, more truth:

A London-based trader with an investment bank agreed the lead seller might not be from Asia. "The selling was on Comex and could also be a non-Chinese fund just executing in what they thought was an illiquid timezone to get the biggest move," the trader said.

Others got close to admitting what happened, but were stopped just short, instead falling back to what had already been set up as the false narrative:

Vishnu Varathan, senior economist at Mizuho Bank, added "there's a good real money presence in centres like Hong Kong and Singapore. But of course, the inside people who knew where the trades were executed probably have their reason for citing Chinese hedge funds, but I don't think they were alone in this trade."


"I think one of the triggers was some disappointment with the amount of the buildup in China's gold reserves so in terms of the proximity of that particular trigger and the markets that were open there was some involvement, I'm sure, but it may not be the full story," Varathan said.

For the record, here is what we said moments after the "bear raid" took place:

Once again, as in February 2014 and on various prior cases, the fact that someone meant to take out the entire bid stack reveals that this was not a normal order and price discovery was the last thing on the seller's mind, but an intentional HFT-induced slam with one purpose: force the sell stops.


So what caused it?


The answer is probably irrelevant: it could be another HFT-orchestrated smash a la February 2014, or it could be the BIS' gold and FX trading desk under Benoit Gilson, or it could be just a massive Chinese commodity financing deal unwind as we schematically showed last March it could be simply Citigroup, which as we showed earlier this month has now captured the precious metals market via derivatives.

We then added: "we won't know for sure until the CME once again explains who violated exchange rules with last night's massive orders."

This is the same CME which took 18 months to admit that the almost identical market halting gold flash crash from January 6, 2014 was the result of potentially premeditated "flawed" algo trading which "resulted in a disruptive and rapid price movement in the February 2014 Gold Futures market and prompted a Velocity Logic event."

And, anticipating precisely today's latest development in the great gold crash story, namely the pursuit of the perpetrators we also added: "there are many who do want to know the reason for the gold crash, which just like in January 2014 had a clear algorithmic liquidation component to it. Which means that until the CME opines on precisely who and what caused the latest gold market break, we won't know with any certainty. That doesn't mean that some won't try to "explain" it.'"

Such as Reuters, on several occasions.

But the real answer, which almost certainly once again points to the trading desk of one Benoit Gilson in Basel, will surely never be revealed. Even in the January 2014 case, the CME stopped short of actually identifying precisely who had oredered the gold collapse instead leaving it broad as follows: "this failure resulted in unusually large and atypical trading activity by several of the Firm’s customers."

Which ones? Or perhaps the $64,000 answer to that question is what the central banks and the BIS, and hence the CME, will guard at all costs.

Finally, as we also noted previously, "while the actual selling reason was irrelevant, the target was clear: to breach the $1080 gold price which also happens to be the multi-decade channel support level."

So far this has almost succeeded, with gold repeatedly sliding just shy of $1080 but never actually breaching it. We expect this too support level to be taken out as what is now clear and accepted manipulation continues, which in retrospect, will merely afford those who buy gold for its true practical value, as insurance against a systemic collapse which is pretty close to where the Chinese central planners find themselves right now not to mention the imploding European monetary union, to buy more for the same paper price.

As for the "great", and greatly misdirecting, hunt for the "bear raid" leader, one which will never reveal the true culprit, bring it on - we can always do with some entertainment meant to distract the masses. In fact, we would not be at all surprised if some Indian trader out of his parent's basement in a London suburb ends up going to prison for this while those guilty of chronic, constant manipulation continue to walk free...

China Electricity Consumption Grows At Slowest Pace In 30 Years

Chinese Electricity Consumption year-to-date grew at 1.3% year-over-year in June. As China People's Daily reports, this is the slowest pace for mid-year in 30 years according to China Electricity Council.



As China People's Daily reports,

China Electricity Council released “A Brief on 2015 Jan.-Jun. Electricity Industry” on July 21, reporting a declined acceleration rate on power consumption of 1.3%- the lowest acceleration rate in 30 years.


According to the brief, the first half of 2015 sees a total electricity consumption of 2662.4 billion kWh all over China. Electricity supply relatively surpasses the demand, but the investment in electricity construction still increases.


The data varies in different areas. There are 19 provinces whose acceleration rates are above the 1.3% national average, and there are 9 provinces whose acceleration rates are below zero.


The data also varies in different industries. Electricity consumption in secondary industry decreases by 0.5%: the very first time to decrease in five years. Electricity consumption in light industry increases by 2.1%, while heavy industry decreases by 0.9%.


Electricity data has long been the barometer of economy. According to China Energy News, experts point out that the decreased acceleration rate is the indicator that China has entered a phase of slower economic development.

*  *  *

While we know only a tin-foil-hat-wearing fringe blog would question the honesty of China's headline macro data, the weakest growth in Electricity consumption in 30 years does tend to suggest things are not as 'unicorns and ponies' as some would have the world believe.

3 Things: Steel, Sentiment, & Productivity

Submitted by Lance Roberts via STA Wealth Management,

Strength Of Steel

Yesterday, I discussed the issues surrounding the Fed's ongoing determination to hike interest rates despite evidence of a weakening economic environment. To wit:

"The Federal Reserve raises interest rates to slow economic growth to keep an economy from overheating which would potentially lead to a sharp rise in inflationary pressures. Since commodities are the basis of everything that is bought, consumed or other utilized; if there were indeed inflationary pressures on the rise commodity prices should be on the rise. As shown, this is clearly not the case."

Last night, the World Steel Association released its June crude steel production report that showed volumes declining to 136 million tons. This is a drop of 2.4% from a year ago.

The decline in steel production, and subsequently the components that go into making steel like iron ore and coking coal, are further evidence that economic activity is far weaker than most analysts currently estimate. This is particularly the case in the U.S. where production of crude steel in June fell by 8.5% on an annualized basis.

Furthermore, the crude steel capacity utilization ratio for the 65 countries that the WSA tracks was 72.2% which is 3.5% lower than a year ago.

It is widely believed the Q1 slump in economic activity was simply a weather/seasonal adjustment error problem. However, there is mounting evidence from other economically sensitive sectors such as retail sales, manufacturing and commodities that there is more to the story.

Steel production is just the latest clue in the solving that puzzle, however, a look at reports (and charts) of basic material companies have been signaling the decline for quite some time. The latest comes from Caterpillar this morning as they once again report a dismal quarter and even worse forecast.

"While economic conditions in the United States are modestly positive, the global economy remains relatively stagnant. Many of the key industries we serve remain weak, and we haven't seen sustained signs of improvement. Continuing economic weakness in China and Brazil, as well as uncertainty in the Eurozone and over Greece, haven't helped confidence. Prices for commodities like coal, iron ore, and oil are not signaling an improvement in the short term."

As Jim Cramer explains:

"The only conference call you will ever need, is Caterpillar, it is my gospel, my go-to call on which many of my decisions are based... I trust Caterpillar's long-term vision... it is a superb evaluator of what's happening in each of the countries it sells in and gives you the most thorough description of each economy."

The message is pretty clear.

Extreme Bearish Sentiment In A Bullish Market

I discussed earlier this week that many of the internal measures of the market were clearly deteriorating even though the market itself remained within a bullish trend and close to recent highs.

However, while the market itself remains "bullish" the sentiment of investors, both individual and professional, has not. The chart below shows the composite index of bullish sentiment smoothed with a 4-month average. While bullish sentiment is decidedly "not bullish" currently, this is not necessarily a "bullish" sign. As noted by the blue vertical dashed lines, declines in bullish sentiment from previous extremes have been normally seen just before the onset of a bigger correction.

Combined with the deterioration in underlying momentum, breadth, and trend; the suggestion is that "risk" is elevated. As I stated previously:

"For investors, it is not the time to become complacent or dismissive of market action. While recent price declines have not violated or changed the current bullish trajectory of the market, it does not mean that such will not eventually become the case."

Economists Can't Explain Lack Of Productivity

There was a time when the U.S. built stuff. Following WWII, the U.S. was a manufacturing powerhouse that built virtually everything the world needed to rebuild itself. After all, the majority of the major global manufacturing centers of the world from Japan to Russia were devasted by the conflict.

Today, however, in the demand by consumers for ever cheaper prices of goods and services, much of the manufacturing has been outsourced to countries with lower costs. In other words, the U.S. has been exporting inflation and importing deflation by reducing the cost of products and services consumed by Americans.

While outsourcing has reduced costs, it only partially explains the decline in productivity. The biggest culprit in the decline of productivity has been the rapid acceleration of labor-saving technologies. Technological advances in automation, drones, robots, software and hardware have allowed people to do more with less. But wait, that is an increase in productivity, right? Correct.

The problem is that the rise in these technological advances ultimately displace workers. In other words, if one person can now do the work of two or three, then there is in effect less productivity because you have reduced the demand for labor. This goes a long way in explaining the inexorable rise in individuals sitting outside the labor force.

Furthermore, the structural shift in employment from manufacturing to service has also reduced the demand for labor. Service related jobs do not have the same economic multiplier effect that manufacturing related jobs do.

The WSJ recently discussed the perplexing issue surrounding the rise in technology and the fall in productivity.

"U.S. productivity, meanwhile, has hit the skids. From 1948 to 1973, it grew at an annual average of 2.8%. The rate through the 1980s slowed to half that, even as computers spread through the economy, driving everything from welding robots in auto plants to bank ATMs.


From 1995 to 2004, it finally looked like the digital age was paying off: Productivity growth rates closed in on post-World War II highs of near 3%. Then average gains fell to 2% from 2005 to 2009; since 2010, they have dipped below 1%.


Ms. Yellen, in a speech in May, said that over time "sustained increases in productivity are necessary to support rising incomes."

Innovation in technology reduces the need for labor. More individuals are sitting outside the labor force increase the demand for available jobs. Increased competition for available jobs suppresses wage growth. It is a virtual spiral that continues to apply downward pressure on an economy based nearly 70% on consumption.

Importantly, what small increases there have been in unit labor costs have primarily come at the expense of higher benefit and healthcare costs rather than an increase in wages. As discussed previoulsy, for roughly 80% of the working labor force, wages have declined over the last five years.

Janet Yellen is right that wages will have a hard time increasing without a pick up in productivity. The issue is that innovation IS the problem, not the solution. That is unless we begin to include the productivity of robots.

Just something to think about.

Congress Will Vote Today to Destroy States’ Rights to Protect Our Food Supply

Painting by Anthony Freda:

All Americans - conservatives and liberals - want their families to have access to safe food.

Polls by ABC news, Associated Press and other major organizations show that Americans overwhelmingly want genetically modified foods ("GMOs") labeled ... and don't believe that GMOs are safe.

A poll by Pew Research Center finds that two-thirds of Americans  think that scientists don’t fully understand GMOs, and therefore cannot guarantee people are safe if they eat genetically modified food

Indeed, most independent scientists - ones not making money from the GMO food manufacturers - say that GMO foods are very concerning.

For example a new study commissioned by Norwegian officials and conducted by a scientific authority on the safety of biotechnologies concludes GMO crops lack scientific data to prove their safety.  And see this.

And a poll shows that 68% of American and Canadian doctors think that GMOs should be labeled.

No wonder Vermont, Connecticut and Maine have voted to require GMO food labels in their states.

So how does our bought-and-paid-for Congress react? By banning GMOs until further studies are conducted? By demanding labeling of GMOs so consumers can decide?

Of course not!

The House will pass a bill today forbidding states from requiring GMO food labeling, or from banning GMOs within their states.

Just like with the TPP, Congress couldn't care less about what the American people want ... or what's good for the country.

Conservatives support states rights. Liberals support federal action to protect our health. And all Americans support our right to make informed purchasing decisions.

But Congress only answer to its owners.

Remember, the big GMO food produces like Monsanto have already gotten their Congressional lackeys to pass legislation which strips American courts of their power.

Postscript:  This is similar to what the Feds did in the run up to the 2008 financial crisis.     As former head S&L prosecutor Bill Black – now a professor of law and economics – notes:

The Federal Reserve Bank of New York and the resident examiners and regional staff of the Office of the Comptroller of the Currency [both] competed to weaken federal regulation and aggressively used the preemption doctrine to try to prevent state investigations of and actions against fraudulent mortgage lenders.

Liberals and conservatives tend to blame our country’s problems on different factors … but they are connected.   The real problem is the malignant, symbiotic relationship between big corporations and big government.

The Company At The Center Of The Criminal Fed Leak Probe Was Just Sold

By now, it is common knowledge that the Fed's leak of material, market moving data to Medley Global's Regina Schleiger has become the reason for not only a Congressional subpoena which Janet Yellen has been resisting because, supposedly, the Fed is above the law and can decide which subpoenas to respond to (and will make sure anyone who dares to ask her any sensitive questions on the topic never speaks to her again as Pedro da Costa found out recently) but also a DoJ and OIG criminal investigation. So far there has been no actual charges as the Fed stonewalls and refuses to cooperate but even if it did, we doubt that anyone would dare to throw the central-planner of the formerly free world in prison.

But what about Medley? Why not subpoena and get sworn testimony from Regina or her employer to find out what happened from the other, less "protected" side? Actually that may have crossed the DOJ's mind.

First, a reminder of just who Medley Global is:

MGA is the leading global provider of macro policy intelligence for the world's top hedge funds, institutional investors, and asset managers. Our services and global network cover G20 plus Emerging Markets, Central Banks & Geopolitics, Global Oil and Energy Markets.

In short: an "expert network" (remember those? that's how Stevie Cohen made his billions paying insiders for material, nonpublic information right under the nose of regulators and enforcers) that leaks Fed decisions and thoughts to its  top-paying clients, such as the report in question leaking the start of QE tapering in December 2012.

Some more on MGA's history:

Medley Global Advisors LLC (MGA) was founded in 1997 by Richard Medley, former chief political strategist to George Soros, to help investors navigate the opaque yet fascinating intersection of policy and markets. Dan Bogler, MGA's President, joined MGA in March of 2010.


From an initial concentration on G3 macro issues, MGA has over the years expanded its network and services to cover G20 countries, Emerging Markets, Geopolitics, Oil and Energy Markets.


Today, MGA has more than 45 experienced professionals with offices in New York, Washington DC, London, and Tokyo. Our client base and policy network spans the globe. MGA's professionals average more than 15 years of experience in the financial markets and the policy world.


Richard Medley left the firm in 2005 when private equity firms Boston Ventures and Castanea Partners purchased the company. In 2006, Goldman Sachs also took a minority share in the firm.

And the punchline:

In February 2010, MGA was purchased by the Financial Times, one of the world's leading business news organisations.

We bring all of this up of course because smack in the middle of the biggest criminal scandal involving the Fed in its history, but also an FT-owned expert network (an FT which until today was owned by Pearson), the expert network known as Medley Global Advisors just changed its owners, from the FT/Pearson to Japan's Nikkei, in a transaction advised by Rothschild for the buyer and Goldman, Evercore and JPM for the seller. From the press release:

Pearson is today announcing that it has agreed the sale of FT Group to Nikkei Inc. for a gross consideration of £844 million, payable in cash.


Financial Times is one of the world’s leading news organisations, recognised for its authority, integrity and accuracy. It includes the FT newspaper,, How to Spend It, FT Labs, FTChinese, the Confidentials and Financial Publishing (including The Banker, Investors Chronicle, MandateWire, Money-Media, Medley Global Advisors and more).

And in light of the fact that the FT had been on the M&A block since 2012 only to see today's dramatic and uite rapid sale concluded in what appears to have been a sprint session, one can't help but wonder: did Medley's association with the FT and thus with Pearson, catalyze today's deal.

Alternatively, now that Medley has new, Japanese owners, does that mean that someone at the DOJ or FBI will, since the Fed is still refusing to cooperate, finally ask a few questions of an expert network whose very existence screams of inside information leakage and a two-tiered market in which the rich have access to all the inside information they can buy while the poor are trolled by Ms. Yellen who advises them of the importance to "build assets."

Big Trouble In Not So Little China...

Why hasn’t the panic of the recent decline followed by the government induced rally spilt over into other markets?  While there was obvious concern that answer is simple enough… The Shanghai Stock Exchange Composite index rose 150% for the 12 months through June 12th. The rally, however, wasn’t based on any material upswing in economic fundamentals. Instead, over much of this period, the economy slowed with both exports and domestic demand weakening as did corporate profits. Capital outflows increased and even with high trade surpluses, the balance of payments turned negative for two quarters. Importantly, the authorities continued to guide public expectations towards lower medium-term growth as they had done over the past two years.

 But after a very lackluster performance at best for the preceding four and half years, sometime at the start of 2H14, market sentiments changed. It is likely that talks of market liberalization, including an opening of the capital account, and in particular the authorities’ presumed intention to “rebalance” the economy’s portfolio from the excessive and worrisome dependence on bank credit to more equity and bond financing is likely to have been the catalyst.  

Starting last November, the PBOC also began cutting lending rates and bank reserve requirements. While the easing was intended to support growth and liquidity, which had dried up because of increased capital outflows, market participants took this as corroboration of the government’s intended “support” for equity market expansion.  

Talks of A-share’s inclusion in the MSCI index that could potentially bring in significant foreign inflows added to the froth and the rally accelerated. China’s onshore stock market has historically been thin on institutional participation with previous rallies largely driven by retail investors. Between 80% to 90% of the China’s market is dominated by retail investors, many of which subscribe to domestic investor newsletters that have been bullish on China’s push towards new tech IPOs. The all led to speculative excess in the ChiNext and Shenzhen exchanges primarily. Hundreds of new brokerage accounts were opened and amateur investors bought on margin. An estimated 4,000 new hedge funds were opened in China in one month, and China had over 200 companies list their shares for the first time, the most of any other country. Studies have shown that most of China’s day traders are working class investors that do not have a college education. They tend to treat stock investing like a day at the horse track.


This time it wasn’t different. For instance, during the past twelve months, the number of individual investor accounts rose from 93 million to 115 million in the Shanghai stock exchange, and rose from 113 million to 142 million in the Shenzhen stock exchange. 

Initially this correction was driven by high valuations, accelerated pace of IPOs, market fears that the monetary easing would slow down, and a tightening of rules on margin financing. Subsequently, the correction intensified as policy measures were seen as inadequate or ill-targeted. 

However this latest correction is not remarkable in the history of China’s stock market. There have been at least two previous cycles since 2000 where the price volatility has been much larger. The previous stock market volatility during 2006-08 was much more dramatic (up 450% between June 2005 and October 2007, and down 70% between October 2007 and October 2008). The impact on the real economy in these cycles was limited, including through wealth effects and contagion to other financial assets.

The development of new market instruments (futures & options), in particular the extensive use of margin financing, hints at potentially more extensive wealth destruction among household and corporate retail investors. For example, margin financing provided by brokerage firms rose from 0.4 trillion yuan in June 2014 to 2.3 trillion yuan at the recent peak level on June 18th (coming back down to about 1.4 trillion yuan by July 9). Compared to previous episodes of stock market correction, this time round there is greater concern over the potential spillover to the real economy, especially as the economy doesn’t have the buffer from strong export growth. China’s export growth has fallen to 0.6%oya during the first five months of this year, after continuously slowing in the past five years from the heady days of high double-digit growth before 2008. In the absence of the buffer from export growth, the burden of keeping up the pace of activity and income has fallen squarely on domestic drivers that could be adversely affected.

The government’s attempt to stem the free fall has involved a number of intrusive interventions in market operations .

• June 27th 2015: Interest rate and RRR cut (China Financials: Reinforcing the Policy Put vs Deleveraging) 

• June 29th 2015: pathways for national pension funds to invest in the equities market; 

• July 1st 2015: a) reduce transaction costs; b) CSRC abolished mandatory requirement on margin calls and liquidation for margin loans; c) broaden financing channels for brokers (China Securities: Policy makers roll out further “market-saving” measures) 

• July 4th 2015: a) 21 brokers pledged to buy blue chips stocks; b) suspending 28 IPOs; (China Securities: A pledge to "national service")

 • July 5th 2015: PBOC to provide liquidity support to CSFC to stabilize the market (More measures to support the A-share market: PBOC to provide liquidity support to CSFC) 

These interventions, along with the voluntary suspension of trading by 43% of the listed companies, do not help promote the orderly development of the equity and corporate bond markets. While these measures are likely to be short-lived and one expects them to be removed once the market stabilizes, the interventions could discourage foreign institutional participation. While the government has recently changed investment norms to encourage local pension and other long-term funds to invest in the stock market, an orderly growth of the equity market typically also requires foreign institutional participation to add depth and maturity as evidenced in other emerging market economies. In the absence of the equity market providing a reliable source of funding, the burden of financing China’s growth would again fall back on bank credit. The experience could also make the authorities more cautious in liberalizing the corporate bond market and outward capital account transactions.

The mainland Chinese stock market only recently opened to investors this year. A handful of qualified institutional investors have had access to that market for less than two years. It’s never been opened to the world.

The market is still immature and although the Chinese have an interventionist mind set, over here we have hardly set the greatest example..we stopped the shorting of stocks during the financial crisis; we bailed out AIG and engaged in massive quantitative easing which at best has altered the price discovery process and put the stock market at major risk on the longer term and although on the face of it they are doing similar actions there are stories of people being arrested or disappearing for minor infractions, brokerage houses that can do nothing but recommend buys….this is not the type of thing to encourage institutional investment. The whole idea of socialism with Chinese characteristics, which is the government mantra, is paradoxical. Chinese communism in charge of a very capitalistic economy has always been a bit mysterious, and something that those from capitalist countries have been puzzled by.


At first glance, it might appear strange to argue that even after a roughly $3.5 trillion loss of market capitalization, the wealth effect on consumption will be limited, but this is likely to be the case While retail participation had increased substantially in the rally, this had not translated into a consumption boom. In fact, retail sales growth slowed when the stock market was rallying. While increases in wealth may not have been immediately translated into higher consumption, the slide could sour consumer sentiment. Moreover, there could be threshold effects if the stock prices continue to downward trend.



The effect on commodity markets, cart or horse?


Much of the global commodity markets have for sometime now been weighed down by the slowdown in China’s growth. With commodities being  used as collateral for borrowing, it is worth noting that the The risk comes when prices fall by a large magnitude within a short time, driving down the value of the collateral.

WTI & Copper charts


With Hong Kong and Singapore’s ratio of bank credit to GDP close to multi-year highs, the risk is that a worsening of credit quality could further tighten credit conditions and dampen domestic demand. In the coming weeks While the Chinese stock market appears to have calmed down, this may not be the true reflection of market sentiments. 

People have been drawing similarities between US 1929-1935 and the Japanese lost decades, but there are  two things tip a country from recession into depression: too much debt, and the way dealing with that debt pushes down prices (i.e. deflation). In 1929 the US messed up by failing to counteract falling prices by freeing up money—in fact, it catastrophically raised interest rates in the immediate wake of the 1929 crash.

When deflation sets in, falling prices cause the relative cost of debt to rise. That sinks debtors in even deeper, and makes would-be borrowers unwilling to take out loans to build their businesses. As people desperately sell off assets to pay back what they owe, they drive prices down even further—exactly what happened in the Great Depression. Unemployment surged to a quarter. More than 5,000 banks failed, taking with them untold sums of household wealth. It wasn’t until 1939 that the US truly emerged from the Great Depression.Although Bureaucrats and bankers believed that with enough time and loose money, they could grow out from under the debt burden.


Japanese growth forecasts have been,shall we say.....poor.....


But Japan had too much debt for that approach to work. Loose money only went to keep broke companies alive—a phenomenon called “zombies”—instead of funding productive investment that might spur the economy. 

The lesson Japan failed to master is that too much debt makes it near-impossible to grow—and that the only way to get rid of that burden is therefore to recognize losses.

Whereas in the Great Depression, lots of companies and banks went bust, in 1990s Japan, hardly any did. America’s bankruptcy epidemic destroyed huge sums of wealth and, as a result, damaged the economy. But it also cleared away debt problems, preparing the country to borrow, invest, and grow again. While the Great Depression lasted just shy of a decade, Japan’s debt woes haunt it to this day, more than 25 years after its stock crash. Much of it’s simply shifted onto the Japanese government’s balance sheet. 


The threat of deflation still looms....


The growth-obsessed Chinese government is clearly going to do everything to prevent a Great Depression—which, at least in the short term, is good news for the global economy.

What’s worrisome, though, is the longer term. Along with the recent stock market bailout effort, aggressive credit loosening, revived infrastructure stimulus, and a steadfast refusal to let companies fail signals that the Chinese government is planning to grow out from under its $30-trillion debt burden. That suggests that China’s leaders are already busy repeating Japan’s mistakes.

Bloomberg Commodity Index weekly chart

Back in 2007/2008, China’s A-shares were trading at 50 times forward earnings and fell 70% from the high and on these current levels the average forward P/E ratios stand at 48.46….the commodity markets are on multi year lows, Let this be a warning......




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Strategic Petroleum Reserve No Longer Key Part Of US National Security

Submitted by Nick Cunningham via,

The U.S. Strategic Petroleum Reserve (SPR), once seen as a cornerstone of America’s energy security, is losing its shine in Washington.

The SPR was established in the aftermath of the 1973-1974 oil embargo, which led to high gasoline prices, fuel rationing, price controls, and long lines at gas stations. The U.S. government decided to stockpile oil in salt caverns in Texas and Louisiana, fuel that could be used in the event of a supply outage. Today, the SPR holds 695 million barrels of oil.

In the decades since, oil from the SPR has only been released a handful of times – including the Persian Gulf War in 1990-1991, Hurricane Katrina in 2005, and during the Arab Spring in 2011.

Sales from the SPR have often undergone quite a bit of scrutiny in the U.S. Congress. It is seen as a stockpile only to be tapped as a last resort measure, with the intention to supply the market only when there is a short-term disruption in supply (as in the examples mentioned above). Even the 2011 sale from the SPR was met with harsh criticism from certain members of Congress, who argued that the petroleum release was not needed.

When President Barack Obama announced the sale of 30 million barrels following turmoil in Libya that knocked supplies offline and raised oil prices, Republicans were incensed. “But by tapping the Strategic Petroleum Reserve, the President is using a national security instrument to address his domestic political problems. The SPR was created to mitigate sudden supply disruptions. This action threatens our ability to respond to a genuine national security crisis and means we must ultimately find the resources to replenish the reserve – at significant cost to taxpayers,” House Speaker John Boehner said in a statement in June 2011.

However, times have changed, apparently. The U.S. Senate reportedly reached a bipartisan agreement this week on a long-term transportation bill that would fund the nation’s highways and transit systems. The problem with transportation legislation is that much of the funding comes from the federal gasoline tax, which, standing at 18.4 cents per gallon, has gone unchanged in over two decades. A combination of inflation and more fuel efficient cars means that the 18.4 cents per gallon tax does not go as far in funding transportation projects as it once did.

But with Congress unwilling to raise the gas tax, they are hunting for other sources of revenue to fund the six-year transportation bill. As a result, they have resorted to raiding the SPR. The bipartisan bill reportedly calls for the sale of 101 million barrels of oil from the SPR between 2018 and 2025.

Although it is unclear if the bill will pass, what is interesting about the move is that the Senate has shed any pretense of national security with the move to sell off crude from the SPR. In 2011, President Obama ostensibly sold off oil in order to supply a disrupted market. His critics argued that it was a cynical political move intended to reduce the price of oil rather than make up for any physical shortage of actual crude oil on the market. But still, the White House argued it was needed.

Now the Senate isn’t even pretending to be pursuing any energy security objectives. The call for the sale of 101 million barrels is being pursued because it will raise an estimated $9 billion for transportation projects. Rather than do what many economists think need to be done – raise the gasoline tax – the Senate has instead decided to abandon a bulwark of U.S. energy security policy put in place four decades ago.

The top Senator on energy issues, Lisa Murkowski (R-AK), admonished her Senate colleagues for dipping into the SPR for an unrelated funding purpose. “The Strategic Petroleum Reserve is a vital national security asset that must be maintained in case of serious future supply disruptions,” Murkowski said in a July 21 statement. “While I recognize that a long-term highway bill is a priority, a shortsighted sale that undermines our emergency preparedness could have real and lasting impacts on our security. On the merits and in its timing, this is simply the wrong approach.”

Of course, maybe the Senate is not off base. Maybe the SPR is no longer needed the way it once was. Even though it is not at capacity, the SPR held 106 days’ worth of oil supply as of May 2014, well above the 90-day supply that the U.S. has pledged to safeguard as a member of the International Energy Agency. And after considering the fact that the private sector holds even more in storage, it could be argued that the U.S. has excess supply sitting on the sidelines, way more than it needs for supply disruptions. That presents an opportunity to downsize the SPR, and in the meantime, use the proceeds for other purposes.

However, there are a variety of reasons why the government should think twice before dismantling or downsizing the SPR. For example, the shale revolution that has cut oil imports may not last over the long-term. Moreover, the U.S. will not be immune to supply disruptions just because it does not import as much oil as it once did.

Still, those arguments are apparently not as potent on Capitol Hill as they once were. As little as four years ago, the President was being accused of undermining U.S. national security by selling SPR oil in order to soften oil prices, which, if true, was at least related to the mission of the SPR. Now, with even less fanfare, a bipartisan group in Congress no longer seems to mind deviating from the mission, and instead seeks to simply sell SPR oil for cash.

PIMCO "Sees Long-Term Value" In Chicago's "Junk" Ahead Of Key Court Ruling

Back in May, the Illinois Supreme Court set a de facto precedent for lawmakers across the country when a bid to cut pension benefits was struck down in a unanimous ruling. Anyone who might have been confused as to the significance of the decision got a wake up call from Moody’s when the ratings agency, citing the read-through for Chicago’s fiscal situation, downgraded the city to junk.

As we noted at the time, Moody’s decision was bad news for a number of reasons, not the least of which was the fact that mayor Rahm Emanuel was looking to refi nearly a billion dollars in floating rate debt into fixed rate notes and borrow another $200 million to pay off the related swaps. The ratings agency’s actions also gave creditors accelerated payment rights, meaning the city could have been on the hook for some $2.2 billion in principal and interest on its outstanding liabilities. 

But the larger story revolves around the implications for other fiscally challenged state and local governments, and as we noted in "States Turn To Pension Ponzi To Plug Funding Gaps," one "solution" is to issue pension-obligation bonds, in what amounts to a nightmarish delay-and-pray scheme that’s virtually assured to end in still larger deficits. Meanwhile, Moody’s has found that using realistic return assumptions to calculate pension liabilities - as opposed to the absurd practice of accepting the assumptions of the pension funds themselves - makes lawmakers angry which is why some officials are now "omitting" Moody’s from deals. "We wanted a fresh set of eyes," one financial officer told WSJ last month referring to the decision to not hire Moody’s. "Yes, a 'fresh set of eyes,' and preferably a set that will not take a realistic look at pension fund return assumptions," we quipped at the time. 

Make no mistake, this is no trivial debate. Almost half of US states face funding gaps for the upcoming fiscal year and the total pension shortfall across states and cities is anywhere between $1.5 trillion and $2.4 trillion depending on who you ask. Against this backdrop, a judge is set to rule on Friday on Chicago’s 2014 pension reform law.

From the Illinois Policy Institute:

A Cook County judge is expected to rule Friday on the legality of a 2014 pension law aimed at reforming two of Chicago’s underfunded city retirement systems. While the pension law included some much-needed reforms, such as an increase in the retirement age, if upheld the law ultimately would put Chicago residents on the hook for millions of dollars of tax increases.

Here are some facts about the 2014 Chicago pension law at issue in Friday’s ruling:

  • The 2014 Chicago pension law only affects two of the city’s retirement funds: the municipal workers’ and laborers’ pension systems.
  • The pension funds for police, firefighters, teachers, parks and transit workers are untouched by this law.
  • The municipal workers’ pension fund has just 41 cents in the bank for every $1 that has been promised in retirement benefits.
  • The laborers’ pension fund has just 64 cents in the bank for every $1 that has been promised in retirement benefits.
  • The pension debt from the two pension systems affected by the 2014 law represents just $8.3 billion in pension debt.
  • In total, Chicago residents are on the hook for more than $34 billion in pension debt, or roughly $33,000 per household.

And while the outlook is most assuredly not good, some say the 8% Chicago recently paid on a taxable bond offering is more than enough to compensate for the risk. Here’s Bloomberg with more on who’s backing up the truck for Chicago’s "junk":

As Chicago wrestles with rising pension costs, cash-strapped schools and a swelling budget deficit, investors from Pacific Investment Management Co. to Wells Capital Management say they aren’t counting the Windy City out.


Wells Capital is increasing its exposure to the junk-rated metropolis, while Pimco said this week it sees long-term value in the city’s debt. A longer-term perspective may come in handy, with a judge to rule Friday on the legality of an overhaul of two of four city employee-pension programs.


The nation’s third-most populous city had to pay yields approaching 8 percent as part of a $743 million taxable-bond offering last week, putting it in the league of junk issuers such as telephone company CenturyLink Inc. A $346 million tax-exempt portion of the sale yielded as much as 5.7 percent.


Already the worst-rated major city except Detroit, Chicago risks being downgraded again if the pension changes are overturned. Yields on Chicago debt are close to the highs reached after Moody’s Investors Service cut the city’s credit rating to below investment grade in May.


"Despite the fact that we all know that they have their problems, and Chicago politics and Illinois politics are really, really difficult, it’s hard to ignore that kind of embedded yields," said Jim Colby, chief municipal strategist at Van Eck Global, which bought some of Chicago’s tax-exempt deal last week. "I know the risks."

Yes, Jim "knows the risks", so stop asking him about it. Of course that’s probably what quite a few folks who went yield chasing in HY energy said earlier this year and we’ve seen how that’s worked out. 

But even if Jim knows, others might not, so Bloomberg, just what are the risks?

The pension system in Chicago is $20 billion short, and the state of Illinois’s retirement fund has a $111 billion shortfall. Chicago’s retirement system is only 36 percent funded as of December 2014, compared to 61 percent in 2005.


A partial solution was found last year when state lawmakers approved a plan, touted by Mayor Rahm Emanuel’s administration, that restructured the pensions of the laborers and municipal workers. That affects about 60,000 workers. The fix forces employees to pay more with lower benefits while also boosting the city’s contribution. Some unions sued to block the law that went into effect Jan. 1.


Friday’s ruling will decide whether that law is constitutional.

Got it. Ok, so let’s just say, for argument’s sake, that the ruling goes against Chicago, what kind of chance do they have on appeal?

The decision is expected to be appealed to the state Supreme Court, which in May unanimously ruled that Illinois couldn’t cut retiree benefits. "Seeing how the state supreme court ruled earlier in the spring, I don’t expect the decision to go favorably for Chicago," said Joseph Gankiewicz, an analyst at Blackrock Inc. in Princeton, New Jersey.

Ok, but let’s ask Chicago’s lawyers - maybe they can tell us why there’s still hope even in the event things don’t go well in the courts.  

If the law is overturned, Chicago’s pensions will be broke in about 10 years, the city’s lawyers have argued.

Obviously the city's legal team has an incentive to make the situation seem especially dire in order to raise the stakes of a negative ruling, but that said, Chicago's fiscal problems aren't set to go away any time soon even under an optimistic scenario. "The city is projecting a budget shortfall of $430 million next year, up from $297 million this year," Bloomberg notes. Indeed, potential investors may want to think long and hard before throwing good money after bad here and on that note, we'll close with the following graph from May which gives you an idea of where things are headed in the windy city.