Today’s News October 2, 2015

• If You Work Here, Quit Before You Are Fired: The 20 Largest US Layoff Announcements Of 2015

  Earlier today, in the latest laughable attempt to boost confidence in a clearly recessionary economy, the BLS reported that a paltry 277,000 Americans had sought unemployment benefits. Why laughable? Because at the very same time, Challenger Gray which actually tracks layoff notices and announcements, released its own data which starkly contradicted the US department of labor.

  As a reminder, what Challenger found was that the third quarter ended with a surge in job cuts, as U.S.-based employers announced plans to shed 58,877 in September, a 43 percent increase from the previous month.

  Worse, while one wouldn’t know it by looking at Dept of Labor data, some 205,759 job cuts were announced in the third quarter, making it the largest job-cut quarter since the third quarter of 2009, when planned layoffs totaled 240,233.

  So according to one data set people are filing for unemployment insurance near the lowest pace in history, according to the other, in the just concluded quarter, we just witnessed the most terminations in 6 years.

  Judging by the economy’s latest trajectory…

  

  … we think we know who is telling the truth, and who is desperate to avoid the reality of the wreckovery.

  So for those eager to push aside the endless government propaganda and concerned about the rapidly deteriorating economy, here is a list of the Top 20 biggest private-sector job cut announcements of 2015.

  We previously profiled the top one, that of Hewlett Packard, as dictated entirely by rising stock-buyback considerations. The same can be said about many of the other corporations, where as long as shareholders continue placing their own immediate interests over the long-term interests of the underlying business viability, none of these companies are safe to work for.

  Our advice: for anyone who is still employed at any of the following corporations, if you can find a job elsewhere (because the “recovery” and all), do it before you too become a seasonally-adjusted pink-slip.

  

  

  

  

  

  

• Russia Is Destabilizing Syria… According To The People Currently Destabilizing Syria

  By Don Shay of Antimedia

  Russia is destabilizing Syria — according to those destabilizing Syria.

  In a move many consider to be an act of bitter defiance to the West, the Russian government appears to have significantly increased its military aid to the Syrian regime. This support hinges largely on the provision of providing advanced weaponry — such as tanks and artillery — training Syrian soldiers to use those weapons systems, and Russian-led airstrikesagainst ISIS. Unsurprisingly, Western media pundits and officials (and their devoted followers) are expressing renewed outrage over Russia’s involvement in the Syrian conflict — at the same time, excluding pertinent background information on Russia’s historical roots in the region.

  Russia’s support for Syria dates back to 1946, when Russia helped consolidate Syria’s independence. The two countries mutually came to a diplomatic and military agreement in the form of a non-aggression pact, which was enacted on April 20, 1950. In this pact, Russia promised support to the newly-created Syria by helping to develop its military and by providing tactical support. Essentially, Russia and Syria have been cooperating for decades both militarily and economically, with Russia maintaining a naval base on the Syrian Mediterranean.

  Regardless of history, it matters little if global consensus opinion supports Russia. The reality is that the war in Syria has no positive outcomes for the people living there. If Assad is removed from power, it is likely the country will fall completely into the hands of ISIS and other terror groups — much like what occurred in Libya and Iraq. The United States’ prospects in the region seem dismal to anyone with a track record of our earlier interventions. If the U.S. placed more emphasis on diplomacy and less emphasis on arming belligerents, however, a political solution to the Syrian conflict would be much more of a possibility.

  A primary criticism of Russia’s relationship with Syria is that arming Assad is an attempt to prolong the conflict and destroy the nation. U.S. pundits point fingers at Russia as if its allegiance with Syria is a new development without understanding the historical intricacies of the Russian-Syrian relationship. In contrast, many individuals complaining about Russia’s role in “destabilizing Syria” and “prolonging the conflict” do not apply the same scrutiny to the United States’ new-found interest in the country.

  It is no secret the United States has armed, trained, and financed the Syrian rebels for nearly the entire duration of the conflict. Does this implicate the United States in prolonging the conflict? U.S.-backed fighters have consistently defected to ISIS and Al-Qaeda, transferring their battle experience and weaponry to virulent terrorist groups. When Al-Qaeda violently occupies villages and towns and ISIS fighters send scores of refugees fleeing for their lives, should the U.S. policy that caused such a catastrophe be questioned?

  Critics concerned by what Russia is accused of doing — destabilizing Syria and prolonging the conflict— should be equally opposed to U.S. intervention in that country. U.S. intervention in Syria, much like U.S. intervention elsewhere, has culminated in unprecedented destabilization and blowback. However, most people — as George Orwell understood — have a lopsided view of history, as they ignore and almost refuse to come to terms with the atrocities their own state commits, and by that logic, ignore the detrimental role the United States has played in Syria.

  The tragedy of the current crisis in Syria is not that hundreds of thousands of people have died or that millions more have become refugees. What makes the death and suffering of so many Syrians tragic is that their pain and grief achieved nothing. It seems there will be no silver lining around the bottomless and ever-expanding pit of war and death in Syria.

  One of the best solutions for a peaceful Syria hinges on the United States completely withdrawing from the region and the U.N. strengthening, instead of impeding, democratic movements that usher in a peaceful transition from chaos to stability. Calling for U.S. intervention in this region is simply perpetuating decades-old Russian-American animosity expressed through what could be considered a proxy war between terrorists on both sides of the political spectrum in Syria. This will only hurt innocent civilians by causing death and destruction — and by extension, promoting continued massive movements of refugees.

  

  

  

  

  

• 72-Year-Old "Mad Dog" Wakabayashi Warns "Reversals Will Be Massive In Scope"

  The infamously named "Mad Dog," 72-year-old former trader Eishi Wakabayashi, who previously called JPY's tops in 1995 and 2011 is out with some dire forecasts.

  Wakabayashi, a former foreign-exchange dealer who built a reputation for long-term chart-based market analysis, predicted the yen’s surge to a then all-time high in April 1995 and also foresaw the end of the strong yen era by early 2012. He joined Bank of Tokyo, now Bank of Tokyo-Mitsubishi UFJ Ltd., in 1966, and earned the nickname “mad dog” for his aggressive trading style.

  As Bloomberg reports, Eishi says the yen has already passed its low and may strengthen to 100 per dollar next year as the Bank of Japan’s unprecedented stimulus is failing to revive the economy…

  “The dollar is destined to decline against the yen because it’s been supported forcibly,” meaning the Japanese currency’s 2015 low of 125.86 was an excessive depreciation, Wakabayashi said in a Sept. 25 interview in Tokyo.  “The quantitative easing worked only psychologically on asset prices, weakening the yen and lifting stocks while failing to boost inflation. That’s become clear and we will see the repercussion from these shock therapies.”

   

  …

   

  Reversals will be massive in scope, possibly driving down the Nikkei 225 Stock Average toward 10,000 from about 17,500 now and the yen will strengthen beyond 100 per dollar next year, he said.

   

  

   

  The world has been in a deflationary cycle since the collapse of Lehman Brothers Holdings Inc., evidenced by the euro, crude oil and a gauge of average commodities futures prices all peaking out in 2008, while risk-asset prices are merely buoyed by aggressive global monetary easing, Wakabayashi said.

   

  As the accommodative policy has failed to end global deflation and artificially inflated risk-asset values are running out of steam, the dollar’s strength is reminiscent of the yen’s appreciation that hurt the Japanese economy during decades of price declines, he said.

   

  “The U.S. will have to eventually resort to a weak dollar policy as deflation deepens,” Wakabayashi said.

  We leave it to "Mad Dog" to sum up…

  “It’s obvious the U.S. is headed for deep deflation, hurt by the strong dollar,” said Wakabayashi, 72. “The Fed raising rates in this environment is not only ridiculous but harmful. U.S. stocks are plunging, not because of the prospect of a Fed rate hike, but to prevent it.”

  

  

  

  

  

• Humans Are No Longer The Apex Predator In Capital Markets (But We Act As If We Are)

  Submitted by Ben Hunt via Salient Partners' Epsilon Theory blog,

  I’m a good poker player. I know that everyone says that about themselves, so you’ll just have to take my word for it. I’m also a good stock picker, which again is something that everyone says about themselves. At least on this point I’ve got a track record from a prior life to make the case. But I don’t consider myself to be a great poker player or a great stock picker. Why not? Because I get bored with the interminable and rigorous discipline that being a great poker player or a great stock picker requires. And I bet you do, too.

  To be clear, it’s not the actual work of poker playing or stock picking that I find boring. I could happily spend every waking moment turning over a new set of cards or researching a new company. And it’s certainly not boring to make a bet, either on a hand or a stock. What’s boring is NOT making a bet on a hand or a stock. What’s boring is folding hand after hand or passing on stock after stock because you know it’s the right thing to do. The investment process that makes a great poker player or a great stock picker isn’t the research or the analysis, even though that’s what gets a lot of the attention. Nor is it the willingness to make a big bet when you believe the table or the market or the world has given you a rare combination of edge and odds, even though that’s what gets even more of the attention. No, what makes for greatness as a stock picker is the discipline to act appropriately on whatever the market is giving you, particularly when you’re being dealt one low conviction hand after another. The hardest thing in the world for talented people is to ignore our mental “shriek of unused capacities”, to use Saul Bellow’s phrase, and to avoid turning a low edge and odds opportunity into an unreasonably high conviction bet simply because we want it so badly and have analyzed the situation so smartly. In both poker and investing, we brutally overestimate the edge and odds associated with merely ordinary opportunities once we’ve been forced by circumstances to sit on our hands for a while.

  As David Foster Wallace puts it so well, “the really interesting question is why dullness proves to be such a powerful impediment to attention.” Why do we increasingly suffer from a “terror of silence” where we use electronic information devices to fill the void? Why are most of you reading this note with at least one TV screen showing CNBC or Bloomberg within easy viewing distance? How many of us are bored to tears with the Fed’s Hamlet act on raising rates, and yet have been staring at this debate for so long that we have convinced ourselves that we have a meaningful view on what will transpire, even though it’s a decision where we have zero investing edge and unknowable risk/reward odds. I’m raising my hand as I re-read this sentence.

  The biggest challenge of our investing lives is not finding ways to process more information, or even finding ways to process information more effectively. Our biggest challenge is finding the courage to focus on what matters, to admit that more or quicker information will not help our investment decisions, to recognize that our investment discipline suffers mightily at the hands of the impediment of dullness. Because let’s be honest… the Golden Age of the Central Banker is a really, really dull time for a stock-picking investor. I’m not saying that the markets themselves are dull or that market price action is boring. On the contrary, this joint is jumping. I’m saying that stock pickers are being dealt one dull, low conviction hand after another by global Central Banks, even though they’re forced to sit inside a glitzy casino with lots of lights and sounds and exciting gambling action happening all around them. We have little edge in a Reg-FD public market. We have at best unknowable odds and at worst a negatively skewed risk/reward asymmetry in a market where policy shocks abound. And yet we find ways to convince ourselves that we have both edge and odds, making the same concentrated equity bets we made back in happier times when idiosyncratic company fundamentals and catalysts were actually attached to a company’s stock price. Builders build. Drillers drill. Stock pickers pick stocks. We can’t help ourselves, even if the deck is stacked against us here in the only game in town.

  Investment discipline suffers under the weight of dullness and low conviction in at least four distinct ways here in the Golden Age of the Central Banker.

  First, just as there’s a winner on every poker hand that you sit out, there’s a winner every day in the markets regardless of whether or not you are participating. The business risk of sitting out too many hands weighs heavily on most of us in the asset management or financial advisory worlds. We can talk about maintaining our investment discipline all we like, but the truth is that all of us, in the immortal words of Bob Dylan, gotta serve somebody. If we’re not telling our investors or our board or our CIO that we have high conviction investment ideas … well, they’re going to find someone else who WILL tell them what they want to hear. And for those lucky few of you reading this note blessed with access to more or less permanent capital, I’ll just say that the conversations we have with ourselves tend to be even more pressuring than the conversations we have with others. No one forces me to “make a play” when I have a middle pair and a so-so kicker, but I’ve somehow convinced myself that I can take down a pot just because I’ve been playing tight for the past hour. No one forced Stanley Druckenmiller – one of the truly great investors of our era – to top-tick the NASDAQ bubble when he bought $6 billion worth of Internet stocks in March 2000. Why did he do it?

  So, I’ll never forget it. January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy at 104 times earnings. This is nuts. Just kind of as I explained earlier, we’re going to step aside, wait for the next fat pitch. I didn’t fire the two gun slingers. They didn’t have enough money to really hurt the fund, but they started making 3 percent a day and I’m out. It is driving me nuts. I mean their little account is like up 50 percent on the year. I think Quantum was up seven. It’s just sitting there.

   

  So like around March I could feel it coming. I just … I had to play. I couldn’t help myself. And three times during the same week I pick up a phone but don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So maybe I learned not to do it again, but I already knew that.

  If living in the NASDAQ bubble can make Stan Druckenmiller convince himself that stocks trading at >100x earnings were a high conviction play only a few months after selling out of them entirely, what chance do we mere mortals have in not succumbing to 6-plus years of the most accommodative monetary policy in the history of man?

  Second, every facet of the financial services industry is trying to convince you to play more hands, and we are biologically hard-wired to respond. I don’t have a good answer to Wallace’s question about why we all fear the silence and all feel compelled to fill the void with electronically delivered “information”, but I am certain that the business models of the Big Boy information providers all depend on Flow. So you can count on the “information” that we constantly and willingly beam into our brains being geared to convince us to join the casino fun. My favorite character in the wonderful movie “Up” is Dug the dog, who despite his advanced technological tools is a prisoner of his own biology whenever he hears the signal “Squirrel!”. We are all Dug the dog.
   

  

  Third, Central Bankers have intentionally sown confusion in our ranks. Like the barkers on CNBC and the sell-side, the Fed and the ECB and the BOJ and the PBOC are determined to force us into riskier investment decisions than we would otherwise choose to make. This is the entire point of extraordinary monetary policy over the past 6 years! All of it. All of the LSAPs, all of the TLTROs, all of the exercises in “Communication Policy” … all of it has been designed with one single purpose in mind: to punish investors who choose to sit on their hands and reward investors who make a bet, all for the laudable goal of preventing a deflationary equilibrium. And as a result we have the most mistrusted bull market in history, a bull market where traditional investment discipline was punished rather than rewarded, and where any investor who hasn’t been totally hornswoggled by Fed communication policy is now rightly worried about having the policy rug pulled out from underneath his feet.

  Or to make this point from a slightly different perspective, while there is confusion between the concepts of investing and allocation in the best of times, there is an intentional conflation of the two notions here in the Golden Age of the Central Banker. The Fed wants to turn investors into allocators, and they’ve largely succeeded. That is, the Fed doesn’t care about your picking one stock over another stock or one sector over another sector or one company over another company. They just want to push you out on the risk curve, which for the vast majority of investors just means buying stocks. Any stock. All stocks. This is why the quality bias that most investors have – preferring solid management, strong balance sheets, and good cash flow generation to their opposites – has been largely immaterial as an investment factor (if not an outright drag on investment returns) over the past 6 years. If the King is flooding the town with easy credit, the deadbeat tailor will do relatively better than the thrifty mason every time. But try telling a true-believer that quality is just an investment factor, no more (and no less) privileged than any other investment factor. Honestly, I’ll get 50 unsubscribe emails just for writing this down.

  Fourth, our small-number brains are good local data relativists, not effective cross-temporal or global data evaluators. Okay, that’s a mouthful. Translation: the human brain has evolved over millions of years and human society has been trained for tens of thousands of years to make sense of highly localized data patterns. Humans are excellent at prioritizing the risks and opportunities that they are paying attention to at any moment in time, and excellent at allocating their behavioral budget accordingly. It’s why we’re really good at driving cars or, in primate days of yore, surviving on the Serengeti plains. But if asked to compare the risks and rewards of a current decision opportunity with the risks and rewards of a decision opportunity last year (much less 10 years ago), or if asked to compare the opportunity we’ve been evaluating for months with something less familiar, we are utterly flummoxed. It’s not that we can’t remember or think on our feet, but there is an overwhelming attention and recency bias in human decision-making. That’s fine so long as we share the market with other humans, much less fine when we share the market with machine intelligences that excel at the information processing tasks we consistently flub. Whether it’s trading or investing, humans are no longer the apex predator in capital markets, but we act as if we are.

  So what’s an investor to do?

  I can sum it up in one deceptively simple sentence: You take what the market gives you.

  It’s deceptively simple because it implies a totally different perspective on markets than most investors (or allocators, frankly) bring to bear. It means approaching markets from a position of humility, i.e. risk tolerance, rather than from a position of hubris, i.e. return expectations. It’s all well and good to tell your financial advisor or your board or yourself that you’re “targeting an 8% return.” That’s great. I understand that’s your desire. But the market couldn’t care less what your desire might be. I think it’s so important to stop focusing on our “expectations” of the market, as if it were some unruly teenager that needs to get its act together and start doing what it’s told. It’s madness to anthropomorphize the market and believe that we can control it or predict its behavior. Instead, we need to focus on what we CAN control and what we CAN predict, which is our own reaction to what a stochastically-dominated social system like the market is going to throw at us over time. Tell me what your risk tolerance is. Tell me what path you’re comfortable walking. Then we can talk about the uncorrelated stepping stone strategies that will make up that path to get you where you want to go. Then we can talk about sticking to the path, which far more often means keeping risk in the portfolio than taking it out. Then we can talk about adaptively allocating between the stepping stone strategies as the risk they generate today differs from the risk they generated in the past. Maybe you’ll get lucky and one of the strategies will crush it, like US equities did in 2013. Excellent! But aren’t we wise enough to distinguish allocation luck from investment skill? I keep asking myself that rhetorical question, but I’m never quite happy with the answer.

  You know, there’s this mythology around poker tournaments that the path to success is a succession of all-in bets where you “read” your opponent and make some seemingly brilliant bluff or call. I’m sure this mythology is driven by the way in which poker tournaments are televised, where viewers see a succession of exactly this sort of dramatic moment, complete with commentary attributing deep strategic thoughts to every action. What nonsense. The goal of great poker players is NEVER to go all-in. Going all-in is a failure of risk management, not a success. I’m exaggerating when it comes to poker, because the nice thing about poker tournaments is that there’s always another one. But I’m not exaggerating when it comes to investing. There’s only one Nest Egg (“Lost In America” is by far my favorite Albert Brooks movie), and thinking about investing and allocation through the lens of risk tolerance rather than return expectations is the best way I know to grow and keep that Nest Egg.

  Taking What The Market Gives You has specific implications for each of the four ways in which the Golden Age of the Central Banker weakens investor discipline.

  1) For the business risk associated with maintaining a stock-picking discipline and sitting out an equity market that you just don’t trust … it means taking complementary non-correlated strategies into your portfolio, as well as strategies that have positive expected returns but can make money when equities go down (like trend-following strategies or government bonds). It rarely means going to cash. (For more, see “It’s Not About the Nail”)

   

  2) For the constant exhortations from the financial media and the sell-side to try a new game at the market casino … it means taking what you know. It means taking what you know the market is giving you because you have direct experience with it, not taking what other people are telling you that the market is giving you. Here’s my test: if I hear a pitch for a stock or a strategy and I find myself looking around the room (either literally or metaphorically) to see how other people are reacting to the pitch, then I know that I’m being sucked into the Common Knowledge Game. I know that I’m at risk of playing a hand I shouldn’t. (For more, see “Wherefore Art Thou, Marcus Welby?”)

   

  3) For the communication policy of the Fed and the soul-crushing power of a risk-free rate that pays absolutely nothing … it means taking stocks that get as close as possible to real-world economic growth and real-world cash flows in order to minimize the confounding influence of Central Bankers and the game-playing that surrounds them. There’s nowhere to hide completely, as the volatility virus that started with the end of global monetary policy coordination in the summer of 2014 will eventually spread everywhere, but there’s no better place to ride out the storm than getting close to actual cash flows of companies that are determined to return those cash flows to investors. (For more, see “Suddenly Last Summer”)

   

  4) For the transformation of the market jungle into a machine-dominated ecosystem … it means either adopting the same market perspective as a machine intelligence through systematic asset allocation strategies, or it means focusing on niche areas of the market where useful fundamental information is not yet aggregated for the machines. In either case, it means leaving behind the quaint notion that you can do fundamental analysis on large cap public companies and somehow gain an edge or identify attractive odds. (For more, see “One MILLION Dollars”)

  One final point, and it’s one that seems particularly apropos after watching some bloodbaths in certain stocks and sectors over the past week or two. Investor discipline isn’t only the virtue of great investors when it comes to buying stocks. It’s also the virtue of great investors when it comes to selling stocks. I started Epsilon Theory a little more than two years ago in the midst of a grand bull market that I saw as driven by Narrative and policy rather than a self-sustaining recovery in the real economy. For about a year, I got widespread pushback on that notion. Today, it seems that everyone is a believer in the Narrative of Central Bank Omnipotence. What I find most interesting, though, is that not only is belief in this specific Narrative widespread, but so is belief in the Epsilon Theory meta-Narrative … the Narrative that it is, in fact, Narratives that drive market outcomes of all sorts. My hope, and at this point it’s only a hope, is that this understanding of the power of Narratives will inoculate a critical mass of investors and allocators from this scourge. Because the same stories and Narratives and low conviction hands that shook us out of our investment discipline on the way up will attack us even more ferociously on the way down.

  

  

  

  

  

• Chinese Cash Flow Shocker: More Than Half Of Commodity Companies Can't Pay The Interest On Their Debt

  Earlier today, Macquarie released a must-read report titled “Further deterioration in China’s corporate debt coverage”, in which the Australian bank looks at the Chinese corporate debt bubble (a topic familiar to our readers since 2012) however not in terms of net leverage, or debt/free cash flow, but bottom-up, in terms of corporate interest coverage, or rather the inverse: the ratio of interest expense to operating profit. With good reason, Macquarie focuses on the number of companies with “uncovered debt”, or those which can’t even cover a full year of interest expense with profit.

  The report’s centerprice chart is impressive. It looks at the bond prospectuses of 780 companies and finds that there is about CNY5 trillion in total debt, mostly spread among Mining, Smelting & Material and Infrastructure companies, which belongs to companies that have a Interest/EBIT ratio > 100%, or as western credit analysts would write it, have an EBIT/Interest < 1.0x.

  As Macquarie notes, looking at the entire universe of CNY22 trillion in corporate debt, the “percentage of EBIT-uncovered debt went up from 19.9% in 2013 to 23.6% last year, and the percentage of EBITDA-uncovered debt up from 5.3% to 7%. Therefore, there has been a further deterioration in financial soundness among our sample.”

  

  To be sure, both the size (the gargantuan CNY22 trillion) and the deteriorating quality (the surge in “uncovered debt” companies) of cash flows, was generally known.

  What wasn’t known were the specifics of just how severe this bubble deterioration was for the most critical for China, in the current deflationary bust, commodity sector.

  We now know, and the answer is truly terrifying.

  Macquarie lays it out in just three charts.

  First, it shows the “debt-coverage” curve for commodity companies as of 2007. One will note that not only is there virtually no commodity sector debt to discuss, at not even CNY1 trillion in debt, but virtually every company could comfortably cover their interest expense with existing cash flow: only 4 companies – all in the cement sector – had “uncovered debt” 8 years ago.

  

  Fast forward to 2013 when things get bad, as about a third of all corporations are now unable to cover their annual interest expense, even as the total addressable corporate debt has soared to CNY4 trillion for just the commodity sector.

  

  And then in 2014, everything just falls apart. Quote Macquarie, “more than half of the cumulative debt in this sector was EBIT-uncovered in 2014, and all sub-sectors have their share in the uncovered part, particularly for base metals (the big gray bar on the right stands for Chalco), coal, and steel.”

  Compared with the situation in 2013, while almost all sub-sectors did worse in 2014, but things appear to have worsened faster for coal companies as more red bars have moved beyond the 100% critical level for EBIT-coverage.

  It means that last year about CNY2 trillion in debt was in danger of imminent default.

  

  The situation since than has dramatically deteriorated.

  So are we now? Macquarie again: “Given the slumps in metal and coal prices so far this year, it’s quite likely the curve will have deteriorated further for commodity firms this year, with total debt getting better in the meantime.“

  In other words, it is safe to assume that up to two-third of Chinese commodity companies are now at imminent danger of default, as they can’t even generate the cash to pay down the interest on their debt, let alone fund repayments.

  We fully expect this to be the source of the next market freakout: when the punditry turns its attention away from macro China, which has more than enough problems to begin with, and starts to focus on the cash flow devastation in China at the micro, or corporate, level.

  

  

  

  

• Drug Shortages, Price Gouging, And Our Broken Health Care System

  Submitted by Michael Accad via The Mises Institute,

  The shaming campaign that followed last week’s news of two generic drug prices somersaulting into the stratosphere after being acquired by private companies is not too surprising. The idea that a drug which cost $13.50 one day can cost $750 the next, seemingly on the whim of greedy Wall Street investors and pharma start-ups, is fodder for the outrage machine.

  But what the outrage machine does not realize is the extent to which the generic healthcare supplies are constantly on the brink of shortage.

  Every week I get a “drug shortage report” by email from my hospital. It lists the various items in short supply. Some drugs (for the most part generic ones) may even be absent from the shelves. And every week, the email also reminds me that there is a national shortage of normal saline.

  

  Normal saline, for heaven’s sake!

  What’s going on? Is our productive capacity in such a shamble that we can’t have the wherewithal to mix sterile salt and water and put it into a bag? Let’s go back to the basics.

  Remember that in order for any product to be available in a sustainable way, there must be a supplier willing to make it and a buyer willing to pay for it at the price the supplier expects. Multiple buyers bid the price up, multiple suppliers bid it down.

  It seems that for something as commodified as normal saline, making plenty of it should not be too much of a problem. After all, there is no shortage of #2 pencils, even if the profit margin on pencils is minuscule.

  Welcome to our glorious world of regulated health economics.

  On the buyer side, you have hospital administrators which have been trained to operate under the reality of fixed payments and onerous oversights. Every expense is a cost that cannot be passed on to the ultimate “consumer” of the good. Therefore, the lower the price of supplies, the better.

   

  On the supply side, the regulatory apparatus overseeing the making of medical products is not known for its flexibility. The last thing bureaucrats want is any intimation that they are not tough enough on bugs and safety. Manufacturers must follow rules which have no regard for market realities and for how much the intended customer will be willing to spend for the product. For something like normal saline, profit margins become dangerously thin and may even be negative.

  In such an environment, the tendency is for consolidation and bureaucratization. Manufacturers with disappearing profit margins merge. Indeed, we are left with a handful of mega-suppliers of hospital commodities. Purchasers also consolidate into large hospital chains or pool their buying resources into purchasing cooperatives.

  These impersonal buyers and sellers, who are further and further removed from the ultimate use of the product, bundle purchases of commodities in large bulks. Normal saline is now bought and sold as a package deal with all sorts of other sundries, like toilet paper, tooth paste, and plastic tubs.

  With the bundling of commodities, the system is prone to miscalculate supply and demand predictions. Demand predictions cannot be made with great accuracy because of the more centralized nature of the enterprise. And if a mismatch were to occur, no one would be held accountable. “There’s a shortage!” administrators on either side would say fatalistically.

  Now, if we’re teetering on the brink of a shortage with something as widely needed and as easily produced as normal saline, it’s only to be expected that we would face actual shortages of generic drugs for rare diseases.

  For the drug maker, the regulatory costs are unchangeable, whether the drug is used by many or by few. At the other end of the transaction, buyers are third-party payers whose interests and willingness to pay do not reflect the needs of the ultimate consumer. Producing generic drugs in such conditions offers no great hope of sustainability.

  Under normal circumstances, if the economics of a product are such that it cannot be manufactured in the country except at a loss, an extremely effective safety valve is provided by the importation market. Lower foreign manufacturing costs can ensure an additional source of supply for the good.

  Not so in healthcare, not so.

  Our wise legislators, encouraged by the pharmaceutical industry and supported by the entrenched regulatory bureaucracy, have decided that importing medications from the outside is a big no-no. “It wouldn’t be safe!” they claim.

  Not safe when we can produce plenty, perhaps. But safer than an actual shortage? Ergo, an opportunity for the “price gouger” about whom we should also add a few words.

  First of all, to the extent that some patients are able to obtain access to the treatment after the price hike, the price gouger provides at least a modicum of service. In her absence, there may be no drug available at all.

   

  Second, “price gouging” is a loose term that has no real economic meaning. There is no particular price increase that defines it. Nowhere in the press will we find what the “break-even” price might be for making cycloserine or pyrimethamine, to inform us of the magnitude of the expected profit.

   

  As a matter a fact, the break-even price of any product can only be guesstimated, and the only one effectively willing to make that guess is the entrepreneur who engages and risks her assets. We must keep in mind that every entrepreneurial activity, however obnoxious it may seem to us, involves incommensurable risk or uncertainty.

   

  It is not in the realm of the impossible, for example, that a price gouger could find himself losing money, even with a 5,000 percent initial price increase: under such conditions, patients and doctors may figure out alternative modes of treatment with existing drugs or (a happy outcome!), deregulation could allow the importation of these drugs from outside, thus evaporating the expected profit.

   

  Third, to the extent that she wakes us up from our stupor, the price-gouger serves as a very effective signaling mechanism, telling us of a gaping unmet need she has managed to find a temporary solution for — however unpleasant and expensive her pill may be to swallow. She thus necessarily invites competitors to follow suit, or prompt us to re-examine the particular economic and regulatory environment that has fostered the shortage in question.

  In a certain sense, then, the character assassination directed at the price gouger is akin to shooting the messenger pointing to the brokenness of our healthcare system. Perhaps it is to that system that the shaming should be directed.

  And we may wish to do that fast. Normal saline could be the next vital supply to dry up.

   

  

  

  

  

  

• Oregon Community College Shooter Asked Victims To "State Their Religion" Before Executing Them

  Update: Details are trickling in about the latest mass shooting in the US and at least some reports indicate that the tragedy might have been tied to religion.

  Here’s a bit of color from The Oregonian:

  The shooter at Umpqua Community College on Thursday asked people to state their religion and then started firing, one student said.

   

  Kortney Moore, an 18-year-old, told the News Review she was sitting in her writing class when a bullet blasted through the window. She saw her teacher shot in the head then noticed that the shooter was in the classroom.

   

  Moore said the shooter told people to get on the ground. He then asked people to stand up and state their religion but started firing anywhere. She was on the ground next to people who’d been shot.

  And here’s USA Today:

  One student, Kortney Moore, 18, told News Review-Today that she was in her writing class in Snyder Hall when a single shot came through a window.

   

  Moore said she saw her teacher get shot in the head, apparently after the gunman came into the classroom. At that point, Moore told the newspaper, the shooter ordered everyone to get on the ground. The shooter then asked people to stand up and state their religion and then started firing, Moore said..

   

  A witness at the scene in Roseburg said the male shooter was shot by police and was acting alone, according The Register-Guard  of Eugene. The report could not be immediately confirmed.

  Finally, here’s The New York Times:

  A 20-year-old man went on a shooting rampage at a community college in Roseburg, Ore., on Thursday, killing multiple victims and injuring at least 20. Officials said the gunman died after an exchange of gunfire with the police.

  Accounts of how many people were dead varied, with officials in the office of the Oregon attorney general, Ellen F. Rosenblum, putting the number at 13.

   

  “We are just heartbroken here in Oregon that an act of this magnitude has occurred in our state,” Ms. Rosenblum told MSNBC. She cautioned that the situation was still developing.

   

  A student, Brady Winder, 23, who moved to Roseburg from Portland three weeks ago, said he was in a room in Snyder Hall adjacent to where at least one shooting took place.

   

  “I heard at least nine shots,” he said.

   

  “There’s a door connecting our classroom to that classroom, and my teacher was going to knock on the door,” Mr. Winder said. “But she called out, `Is everybody O.K.?’ and then we heard a bunch more shots. We all froze for about half a second.”

   

  “We heard people screaming next door,” he said. “And then everybody took off. People were hopping over desks, knocking things over.”

  The tragedy is the latest in a string of violence that most recently included the murder of a Virgina TV reporter and cameraman on air and which just months ago saw nine people killed at an African American church in Chareleston, South Carolina. 

  *  *  *

  Update: the shooter has been killed following a firefight with sheriff deputies:

  LATEST: Gunman in Umpqua Community College shooting killed in firefight with sheriff’s deputies https://t.co/YBlzoOIuuc #UCCShooting

  — NBC News (@NBCNews) October 1, 2015

  BREAKING: Oregon Gov. Kate Brown says gunman in mass shooting at college was 20-year-old male.

  — The Associated Press (@AP) October 1, 2015

  MORE: Shooter in #UCCShooting was 20-year-old male, says Oregon governor https://t.co/YOBbW312BS – @CBSNLive pic.twitter.com/24QaiPYkwr

  — CBS News (@CBSNews) October 1, 2015

   

  * * *

  Moments ago, following a lull in reports of US mass killings, the newswires lit up with reports of the latest “active shooter” incident this time on the campus of Umpqua Community College in Oregon, where according to KATU 2 News, 14 people were killed and at least 20 injured in what is still a developing situation.

  The Oregonian reports:

  A shooter has been reported at Umpqua Community College, according to the Douglas County Fire District’s Twitter account. It’s unclear how many wounded or if the shooting is still ongoing at the Roseburg campus.  Sgt. Dwes Hutson, a Douglas County Sheriff’s Office spokesman, says officers responded around 10:40 a.m. to reports of a shooting at the College. Huston could not confirm if anyone was injured.

  The LA Times adds that the injured include a woman who was shot in the chest, said Chris Boice, a Douglas County commissioner. The shooting began within the last 30 minutes at Umpqua Community College. 

  The good news: the shooter is “down and in custody,” Boice said.

  
  

  MORE: Sheriff’s office tells CBS News threat is over at Umpqua Community College https://t.co/PwXThs4WO2 pic.twitter.com/JMorBEU6DQ

  — CBS News (@CBSNews) October 1, 2015

  More details:

  Oregon State Police confirm 15 dead in #UCCShooting. #LiveOnK2

  — KATU News (@KATUNews) October 1, 2015

  #BREAKING: UPDATE: Oregon State Police say 15 confirmed dead in mass shooting at Oregon’s Umpqua Community College in Roseburg. — @KATUNews

  — Tim Williams (@realtimwilliams) October 1, 2015

  #BREAKING: Oregon State Police say at least 10 killed people, 20 others injured in shooting at Oregon’s Umpqua Community College in Roseburg

  — Tim Williams (@realtimwilliams) October 1, 2015

  Police: Preliminary reports indicate 10 killed, 20 others injured in shooting at Oregon’s Umpqua Community College. https://t.co/k2gnvMc29u

  — CNN Breaking News (@cnnbrk) October 1, 2015

  Active shooter reported at Umpqua Community College. One person reported shot.

  — Ian Campbell (@MrCampbell17) October 1, 2015

  Shots fired on UCC campus. Lock down and do not come to campus until further notice.

  — John Blackwood (@jblackwooducc) October 1, 2015

  Scanner reporting approx 20 are wounded #UCCShooting

  — Ian Campbell (@MrCampbell17) October 1, 2015

  Multiple ambulances driving very fast AWAY from #UCCShooting

  — Ian Campbell (@MrCampbell17) October 1, 2015

  Authorities still unsure of whether the suspect has been apprehended at #UCCShooting

  — Ian Campbell (@MrCampbell17) October 1, 2015

  * * *
  And then this:

  A student tweets about shooting at her Oregon community college, and TV producers ask if she can call them right now pic.twitter.com/41Tn9Mc5Tf

  — Matthew Haag (@matthewhaag) October 1, 2015

  

  

  

  

• US Mint Sees Record Silver Sales In Q3 As Physical Demand "Is Absolutely Through The Roof"

  Having recently pointed out the surging premiums for physical gold and silver relative to the 'paper' prices spewed forth by the mainstream media, it will likely come as no surprise that, as Reuters reports, "silver [coin] demand is absolutely through the roof," according to the Perth Mint. Confirming the demand side is the U.S. Mint sold 14.26 million ounces of American Eagle silver coins in the third quarter, the highest on records going back to 1986. Dealers and mints trace the supply squeeze to a burst of buying by mom-and-pop investors in the United States, who scrambled to scoop up coins they considered to be at bargain levels after spot silver prices in early July sank to six-year lows.

   

  As Reuters reports,

  The global silver-coin market is in the grips of an unprecedented supply squeeze, forcing some mints to ration sales and step up overtime while sending U.S. buyers racing abroad to fulfill a sudden surge in demand.

   

  The U.S. Mint began setting weekly sales quotas for its flagship American Eagle silver coins in July because it can't meet demand, and the Canadian mint followed suit after record monthly sales in July. In Australia, the Perth Mint sold a record of more than 2.5 million ounces of silver this month, nearly four times more than in August, and has begun rationing supply of a new line of coins this month, a mint official said.

   

  "Silver [coin] demand is absolutely through the roof," said Neil Vance, wholesale manager at the Perth Mint.  "There seems to be a bit of frenzy as people think there is a shortage of silver. But in fact it is a (crunch in) manufacturing capacity."

   

  While demand has risen in response to the slump in spot prices to $14.33 an ounce in late July and its subsequent drop to fresh six-year lows below $14 an ounce in August, mint officials also said they were caught out by the sudden interest in coins. In July, the U.S. mint halted sales for almost three weeks after running out of "blanks", which are used to make coins.

  The spread between silver and gold, a closely watched gauge for the precious metals markets, has risen to its highest in the third quarter since a brief silver frenzy following the financial crisis. Silver coins typically outsell gold anyway because they cost less, but the wide spread meant the silver price is 76 times cheaper than gold, making it even more appealing than usual to investors.

  The U.S. Mint sold 14.26 million ounces of American Eagle silver coins in the third quarter, the highest on records going back to 1986. The Canadian mint has been limiting sales of its silver Maple Leaf coins since July after record monthly sales that month, an official told Reuters. Sales were at all-time highs in August and September.

  With North American mints overwhelmed by orders, investors and collectors were forced to look overseas for increasingly scarce supplies, triggering a domino effect in Europe and Asia.

  "We can only get a fraction of what we could sell," said Terry Hanlon, president of Dillon Gage, one of the world's biggest precious metals dealers, based in Addison, Texas.

   

  Hanlon said he has seen premiums for coins, which are paid on top of the spot price for physical delivery, surge to about $4 to $5 per coin in wholesale deals, compared with $2.30 in June.

   

  

  For now, however, coin dealers are riding the wave.

  Bullion dealers around the globe who typically offer next-day delivery are now taking silver coin orders several weeks out.

   

  "I don't expect things to get better until next year," said Gregor Gregersen, founder and director of retailer Silver Bullion based in Singapore.

  

  

  

  

  

• "There Are Five Times More Claims On Dollars As Dollars In Existence" – Why This Matters

  Submitted by Paul Brodsky of Macro Allocation

  
  

  According to the Fed, there is about $60 trillion of US Dollar credit (claims for US dollars):

  

   

  Also according to the Fed, there are about $12 trillion US dollars:

  

   

  So, the data show plainly there are five times as many claims for US dollars as US dollars in existence. Does this matter to investors?

  Well, yes, it matters a lot. Not only is there not enough money to repay outstanding debt; the widening gap between credit and money is making it more difficult to service the debt and more difficult for nominal US GDP to grow through further credit extension and debt assumption. Remember, only a dollar can service and repay dollar-denominated debt. Principal and interest payments cannot be made with widgets or labor, only dollars.

  This means that future demand and output growth generated through more credit issuance and debt assumption is self-defeating. In fact, it adds to the problem. Credit-generated growth is not growth in real (inflation-adjusted) terms because rising GDP, which engenders an increase in money, is also accompanied by a larger increase in claims on that money. Why larger? Because debt comes with interest.

  By definition then, debt compounds while real growth does not. In fact, economies naturally economize because innovation and competition tend to drive prices lower. This natural deflation works against debt service and repayment that needs perpetual inflation.

  As we know, for thirty years beginning in the early 1980s the Fed helped the US and global economies grow consistently more or less by reducing interest rates, which gave consumers of goods, services and assets incentive to take on more debt. Following the inevitable debt crisis in 2008, the Fed had to reduce the overnight interest rate it targets to zero percent.

  As we also know, to keep the economy growing from there, the Fed then had to begin creating money, which it did through quantitative easing (QE). It bought assets directly from the money center banks it deals with (primary dealers), and paid for them with the newly created money. At the same time, the Fed paid these banks – and continues to pay them – interest on the money they created for them (Interest on Excess Reserves). This provides a disincentive for banks to lend to the public, which is how the Fed is trying to control US growth and inflation today.

  The long and the short of this discussion is that either the Fed and other central banks overseeing highly leveraged economies must inflate their money stocks and get the new money into the hands of debtors, or inflate their money stocks and get the new money to creditors. The former would make systemic debt service and repayment easier. The latter would keep creditors solvent when debtors inevitably default. The economic impact of getting new money in the hands of debtors would be significant inflation. The economic impact of creating more bank reserves would be significant economic austerity (a full-blown depression). Why? Because debtors would be increasingly starved of the ability to service and repay debt.

  Impact on Assets

  Investors might ask themselves how two pools of dollar-denominated assets can be valued collectively at $38 trillion ($19 trillion each for US Treasuries and US equities), when there is only $12 trillion in existence? Not only does this gross imbalance not include the market value of other assets, like other bonds and real estate; it also does not include the value of the US private capital stock, such as inventory, resources, enterprises, and collectibles. (Economists might want to think about this too.)

  In short, the value of dollar-denominated assets is not supported by the money with which it is ostensibly valued. This has not been a problem historically because the proportion of un-reserved credit has been low relative to asset values and cash flow. As we are seeing today, however, it is becoming a significant problem because balance sheets are already highly levered and zero-bound interest rates chokes off the incentive to refinance asset prices higher.

  If the total value of US denominated assets is, say, $100 trillion, and the US dollar money stock is somewhere around $12 trillion, then the inescapable implication is that the market’s expects either: a) $88 trillion more US dollars will be created in the future to fund the purchase of the gross asset pool at current valuations; b) there has to be a decline in the nominal value of aggregate assets, or; c) both.

  Obviously there never has to be a full exchange of assets for money because there will always be asset holders wishing to keep their assets. But that is not the point. The issue is that there is a significant rate of inflation embedded in the currency (clearly higher than 2% targeted by the Fed), and/or a significant rate of deflation embedded in assets.

  What forces the issue? Production, or the lack thereof. If/when the value of asset prices exceed the value of production by an amount that disincentives production, GDP will contract.

  Warren Buffet is famous for considering the total market capitalization of US equities against GDP. While this Market Cap-to-GDP ratio provides a clue as to how easy or difficult it may be at any point in time for public companies to generate higher revenues and earnings relative to past equity markets, it does not consider the dynamic driving demand for goods and services in the broader economy.

  In other words, it does not consider what actually drives GDP. The presumption is that nominal GDP will always grow. This is not necessarily a bad assumption (in fact it is a reasonable one for reasons we will discuss next week), but it does not consider how the pursuit of nominal growth in today’s macro environment will actually reduce real growth and real ROI.

  It is that easy. We think there will continue to be an inflationary deleveraging in the US and across the world, and ultimately significant widespread inflation. More on this next week.

  Mr. Buffet and most investors have not had to be concerned during the secular leveraging phase with output contraction in real terms, and so they have not had to be concerned with negative real ROIs. Looking forward, we think it is becoming increasingly obvious that wealth and alpha will be created by allocating capital to assets in which price and real value are closely aligned.

  Un-levered assets should outperform levered assets. Businesses that sell to less levered consumers should outperform businesses that sell to levered consumers; and so on.

  

  

  

  

• Wall Street Banks Admit They Rigged CDS Prices Too

  Back in June, we noted that a group of investors which included hedge funds, pension funds, university endowments, and others were looking to push forward with a lawsuit that alleged Wall Street had conspired to limit competition in the CDS market. 

  Of course the whole case was based on what amounts to tautological reasoning. 

  That is, everyone knows that Markit effectively monopolized the CDS market and because Markit was owned by Wall Street, it was self evident that big banks both monopolized and manipulated the market. 

  Amusingly, one of the firms that plaintiffs alleged was kept out of the credit default swap market as a result of Wall Street’s absolute stranglehold was Citadel. As we joked a few months back, this meant that by conspiring to keep the Fed’s plunge protection team shut out in 2008, Markit and Wall Street robbed the world of the chance to see what happens when VIX 90 meets HFT, meets CDS market making.

  In any event, earlier this month, the Street agreed to settle for nearly $2 billion and today we learn that none other than JP Morgan – whose offshore, taxpayer sponsored hedge fund at CIO seems to have quite a bit of trouble trading CDX without losing billions – is set to bear the brunt of the pain. Here’s Bloomberg: 

  JPMorgan Chase & Co. is set to pay almost a third of a $1.86 billion settlement to resolve accusations that a dozen big banks conspired to limit competition in the credit-default swaps market, according to people briefed on terms of the deal.

   

  JPMorgan is paying $595 million, with the lender’s portion of the accord largely based on the plaintiffs’ measure of market share, said the people, who asked not to be identified because the firms haven’t disclosed how they’re splitting costs. The settlement also enacts reforms making it easier for electronic-trading platforms to enter the CDS market, according to a statement Thursday from the attorneys for the plaintiffs, which include the Los Angeles County Employees Retirement Association.

   

  Morgan Stanley, Barclays Plc and Goldman Sachs Group Inc. are paying about $230 million, $175 million and $164 million, respectively, the people said. Plaintiffs’ lawyersdisclosed the approximate size of the settlement in Manhattan federal court last month, saying they were still ironing out details. They updated the total in Thursday’s statement.

   

  The accord averts a trial following years of litigation by hedge funds, pension funds, university endowments, small banks and other investors, who sued as a group. They alleged that global banks — along with Markit Group Ltd., a market-information provider in which the banks owned stakes — conspired to control the information about the multitrillion-dollar credit-default swap market in violation of U.S. antitrust laws.

  So yes, even the marks for the financial weapons of mass destruction that helped to destroy the financial universe were (and probably still are) manipulated, meaning that you can’t even bet against something without falling victim to big bank rigging. 

  Whether or not allowing other players (like Citadel) to enter the market will ultimately be a positive or a negative is anyone’s guess, but the bottom line is that at the end of the day, there wasn’t anything Wall Street didn’t control.

  Here is a system that ultimately allows banks to control the pricing for the instruments they use to bet against securities that they themselves create. This is just part and parcel of a never-ending paper wealth creation machine which generates billions in fiat money profits without creating anything in the way of tangible value and before it’s all over, this financialization of the US economy will likely end up bringing the world to its knees unless someone, somewhere puts a stop to the madness. 

  

  

  

  

  

• HFTs Have Devolved To Two-Bit Criminals Straight Out Of "Office Space"

  Back in October 2011, Zero Hedge was first to point out something previously unknown: a small, then-unheard of firm, managed to upstage none other than Goldman Sachs when it comes to total weekly program trading volume on the NYSE.

  Since then Latour, an affiliate of Tower Trading, has emerged as one of the pre-eminent HFT powerhouses in NYC. As we subsequently learned, Tower Research – which is run by Mark Gorton of LimeWire fame – is a member of the upstart Modern Markets Initiative, a lobby firm whose stated purpose is focused on “demonstrating the benefits of algorithmic or quantitative trading, often referred to as high-frequency trading, in today’s modern markets.”

  It has failed to do that.

  Instead, it has demonstrated, twice in the span of one year, that HFTs are nothing but two-bit, small-time criminals, intent on breaking all the rules, frontrunning clients, and otherwise abusing market ethics and norms.

  In short: HFTs rig markets constantly, and what’s worse: they are now getting so behind the curve, the SEC is catching them in the act on an almost daily basis.

  Which brings us back to Latour and September 2014, when one year ago the SEC – in its first enforcement action against a high-frequency trading firm – charged Latour Trading for using faulty calculations in complex trading strategies that let it buy and sell stocks without holding enough capital. The firm at times accounted for 9% of all U.S. stock trading, according to the SEC’s order.

  As the WSJ reminds us, Latour, which didn’t admit or deny wrongdoing, agreed to pay $16 million to settle the case, the largest penalty for a violation of the so-called net capital rule, the SEC said.

  The net capital rule provides various methodologies that broker-dealers need to follow to make sure they are adequately taking account of the risk they are exposed to from their market activities. Latour routinely violated those requirements from 2010 through 2011, the SEC said.

  Latour said it had “fully remediated the problems described in the Commission order, and we are pleased to put them behind us.”

  It was so pleased in fact, that it couldn’t wait to get busted for more manipulation.

  Fast forward to yesterday when the same Latour  was found to have violated even more SEC rules – in this case the Market Access Rule and Regulation National Market System – over a nearly four-year period in which Latour sent millions of non-compliant orders to U.S. exchanges.  According to the order:

  • Latour shared portions of its electronic trading infrastructure with its parent company, Tower Research.  Some Tower Research employees could change the computer code without Latour’s knowledge or approval.  Latour’s procedures to prevent such changes from having unintended effects on Latour’s trading proved inadequate.
  • In June 2011, Tower Research made a coding change that introduced an error into the shared infrastructure and, as a result, Latour sent millions of orders to exchanges that did not comply with the requirements of Regulation NMS.  Some of these orders were executed, which led to Latour receiving gross trading profits and also rebates paid by stock exchanges.
  • Latour lacked “direct and exclusive control” over its financial and regulatory risk management controls as required by the SEC’s Market Access Rule and did not have adequate post-trade surveillance tools to detect its non-compliant trades.
  • After learning of the error, Latour corrected many of the issues by October 2012 and addressed the rest by August 2014.

  Some more details:

  According to the SEC’s order, from October 2010 through August 2014, Latour sent approximately 12.6 million orders for more than 4.6 billion shares that did not comply with the requirements of Regulation NMS.  The orders at issue were intermarket sweep orders (ISOs), which trading centers may immediately execute at prices that might otherwise appear to violate Rule 611 of Regulation NMS.  Rule 611 generally requires trades to be executed at the best available displayed price, but trading centers may execute ISOs immediately based on the ISO router’s obligation to send additional orders to execute against any better-priced displayed quotations.  Chiefly because of the coding problem, Latour’s ISOs did not meet the requirements and caused more than 1.1 million trade-throughs (trades executed at a price worse than the best available price) and more 1.7 million locked or crossed markets (when the national best bid equals or exceeds the national best offer).   Latour also sent non-compliant ISOs as a result of incorrectly relying on information about orders that Latour had previously sent.  In addition to violations of the Market Access Rule, the SEC’s order also finds that Latour violated Rule 611(c) of Regulation NMS because it did not take reasonable steps to establish that its ISOs complied with Reg NMS.

  How much money did Latour make? 

  “Latour sent nearly 12.6 million non-compliant ISOs between October 2010 and August 2014. These non-compliant ISOs caused approximately 1.1 million trade-throughs and 1.7 million locked or crossed protected quotations. Latour received $2,784,875 in gross trading profits and exchange rebates from its non-compliant ISOs.”

  So the “error” resulted in a magical $2.8 million in profits. Of course, this is only on the rigging that the SEC did catch. One can imagine how many millions in other profits Latour extracted by rigging the market and flaunting regulations, using illegal strategies that the SEC has no clue about. We doubt we will find out.

  To summarize: mysteriously and “erroneously” a change in the company’s  code was made, which the firm lacked “direct and exclusive control” over, and which was non-compliant with Reg NMS requirements, yet which mysteriously ended up generating “gross trading profits and rebates by stock exchanges” amounting to $2.8 million.

  Where have we seen this?

  Oh yes.

   

  And that’s what the secret sauce behind the HFT “wizards” that dominate the market has devolved to: a B-grade movie about two-bit crooks.

  * * *

  Oh, what was Latour’s penalty for getting caught rigging markets twice in one year? The answer: $8 million (following another $14 million settlement a year ago).

  Not a single algorithm, or 21-year-old math PhD, was perp walked.

  

  

  

  

  

• Apple, Amazon, Tesla and the Changing Dynamics of the Car Industry

  Writing is a very weird experience for me. Sometimes it feels almost like an act of divine intervention. Not because of the divinity of it, but because of the intervention part. It’s almost as if I were a conduit for a guy (at least I hope it’s a guy) inside my head trying to communicate with my readers. I sit down to write, and letters spill into words and then into sentences, and then I see these new ideas and find myself thinking, “Wow, I wish I’d thought of this!”

  After I submitted my previous column, on the financial innovation taking place at Apple, I learned that Sprint, T-Mobile and now Verizon are all fighting to best one another’s iPhone offers. What is really amazing about the situation is that no matter how this war among wireless carriers plays out, there will be one clear winner — Apple. And in the end, the carriers will be collective losers — they’ll be killing their margins to out-subsidize one another. They will be spending millions of dollars on advertising to get customers to come to their stores to buy — yes, Apple iPhones. If consumers choose Apple’s iPhone Upgrade Program instead of the carriers’, then Apple will win even bigger (as I argued in that column). In the meantime, 2015 will likely mark the year that AT&T’s and Verizon’s U.S. wireless service businesses went from growth to stagnation.

  Another observation about Apple: Its brand extends far beyond technology and coolness. Over the years, the company has accumulated incredible goodwill with consumers. There is only one other company that comes to mind that has generated a similar amount of affection: Amazon.com. Amazon made shopping online easy, its customer service is impeccable, and it is transparent with consumers about pricing. After all, it allows other merchants to sell their merchandise through its website. Amazon will even ship it for them.

  Consumers’ trust in Amazon’s pricing is so great that most people don’t even bother with comparison shopping anymore; they skip Google (which is not good news for Google, by the way) and go directly to Amazon. I recently found myself willing to pay a few dollars more on Amazon than on a competitor’s website because I knew that if I needed to return the product, the process would be seamless. That goodwill turns Apple and Amazon into “platforms” (a very trendy word on Wall Street now), allowing them to launch a wide variety of new products.

  When Apple comes out with the Apple car, rumored to be due in 2019, it will be able to grab a disproportionately large market share from the General Motors of the world because of that deep well of goodwill.

  By the time my youngest child, Mia Sarah, who is almost two, learns to drive, internal combustion engines will likely be a relic consigned to museums (just like Ford’s Model T). I had an “aha!” moment when I recently visited a Tesla store and saw its cars’ power train. It looks just like a skateboard — it basically consists of a flat slab of metal (which houses the battery), four wheels and an electric engine the size of a large watermelon. That’s it — the Tesla has only 18 moving parts. I don’t know how many moving parts an internal combustion engine (ICE) car has, but it must be hundreds if not thousands. Interestingly, ICE cars also have more electronics than a Tesla.

  Wall Street is going gaga over the stocks of dealerships (especially after Warren Buffett’s Berkshire Hathaway bought Van Tuyl Group) and car makers. I am in the minority, but I think that party will come to an end. Just like Tesla, Apple is not going to be using a dealership model to sell its cars. It would not want the Apple car buying experience to be tainted by a sleazy car salesman. Just as with the iPhone, the company will want to have complete control of the buying experience.

  If both Tesla and Apple bypass the dealership model, the GMs of the world will be at an even larger competitive disadvantage. They will have to abandon the dealership model too. Yes, I know, selling cars directly to consumers is not legal in many states, but if the U.S. Constitution could be amended 27 times, the law on car sales (which is an artifact of the Great Depression) can be amended as well.

  The traditional dealership model is unlikely to survive anyway, as its economics dramatically degrade in the electric-car world. A car that has very few moving parts and minimal electronics has few things to break; and consequently, electric cars will need less servicing — throttling the dealerships’ most important profit center.

  The baby boomer generation romanticizes cars. Most boomers can recite the horsepower and other engine specs of every car they have ever owned. For the tail end of Gen X (my generation) and Millennials, a car is an interruption betweenFacebook and Twitter. We know the brand of speakers in our car, but if asked would have to google its horsepower. We feel little romanticism for our cars and have much higher brand loyalty to Apple and Google than to GM or Ford.

  What is also amazing about electric cars is that they aren’t that much different from smartphones. Smartphone prices have declined significantly over the years because their components became ubiquitous and commoditized. With the exception of spark plugs and tires, most components of a GM car will be different from the ones you’ll find in a Ford. The opportunity for scaled manufacturing and so commoditization is very limited in the auto industry.

  The simplicity of electric cars and the declining ambition of Tesla, Apple and whoever else enters that space to be known as a “car” company will likely lead to commoditization of components and thus lower prices. Tesla today is more a software and battery company than a car company. (As we recently discovered, Volkswagen is a lot more of a “software” company than we thought.)

  Think back eight years ago to the day when Apple introduced the iPhone. No one suspected that it (and the smartphones that followed) would enable a service likeUber, which is busy putting cabdrivers worldwide out of business. The unforeseen consequences of the advent of electric cars will reverberate much farther than the demise of dealerships and significant shifts in market share in the auto industry.

  Gasoline can only be made from oil. (Yes, there is ethanol, but the economics of ethanol in the U.S. are problematic.) Sources of electricity are diverse — natural gas, coal, nuclear, solar, wind, hydro, oil (and I’m sure I’m forgetting something). Seventy percent of oil goes into cars and trucks. Just imagine for a second the shifts in global political alliances if oil lost its luster. The U.S. might forget how to spell “Saudi Arabia,” and the Middle East might start looking very different.

  Apple may find its 2019 date for the Apple car to be a bit optimistic, but nevertheless, its entrance into the auto industry will likely be successful and very disruptive. After all, it has the much-needed software know-how to design a car (it is already working with car companies on CarPlay, the iPhone-centered car infotainment system), it boasts a global network of stores, it has a deep well of goodwill with a billion fans globally, it possesses unlimited resources ($150 billion of net cash, and it generates $50 billion of free cash flows a year), and its imagination has not been damaged by decades of producing cars with internal combustion engines.

  Let me stress that last point. There is a very good reason why Nokia, which at one time was the dominant cellphone manufacturer, failed to compete with Apple’s iPhone. It had too much institutional knowledge. It had hundreds of engineers who tried to add IQ to a dumb phone. They were attempting to convert Symbian, a dumb phone operating system, into a smart phone operating system. Despite Apple showing Nokia how the smartphone should look, they couldn’t see their product as a smartphone but rather just as the next iteration of a dumb phone.

  General Motors’ answer to Tesla was not any different from Nokia’s response to the iPhone. GM came out with the Chevy Volt, which was really one of its internal combustion engine cars with an electric engine dumped in. Unless an ICE car company creates a silo unit isolated from the rest of the operation, it will be very difficult if not impossible to get engineers who have designed ICE vehicles all their lives to suddenly change the paradigm of their thinking and turn into electric-car engineers.

  This article was originally published on Institutional Investor .  Read Vitaliy’s II articles here.  

  Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of Active Value Investing (Wiley 2007) and The Little Book of Sideways Markets (Wiley, 2010).  His books have been translated into eight languages.  Forbes called him – the new Benjamin Graham.   

  To receive Vitaliy’s future articles by email  click here.

  

  

  

  

• The Looming Medicaid Time-Bomb

  Submitted by Robert Romano via NetRightDaily.com,

  From 1985 through 2011, an average 11.7 percent of seniors were enrolled in Medicaid, primarily for long-term nursing home or home and community care, according to data compiled by the Centers for Medicare and Medicaid Services (CMS) and the Bureau of Labor Statistics.

  Keep that stat in mind, because if it remains true, as the Baby Boomers progress through old age, by 2030, as many as 8.7 million seniors could be enrolled in the program, up from 4.6 million today, an Americans for Limited Government analysis of the data reveals. By 2035, that figure could rise to about 9.3 million.

  And it will drive the costs of the program to the moon, particularly the costs for long-term nursing home and home care targeted at elderly and the physically disabled, which stood at $88.85 billion in 2013. Why?

  As the Urban Institute’s Melissa Favreault noted at the Department of Health and Human Services Assistant Secretary for Planning and Evaluation Long-Term Care Financing Colloquium on July 30, “We project that formal long-term services and supports use and costs will roughly track the growth in the aged population.”

  That is not good news, particularly considering the older age population wave now underway.

  By 2035, the number of seniors will have increased 66 percent to 79.2 million, the U.S. Census Bureau projects. 66 percent.

  As jaw-dropping as that is, in the meantime the population of those aged 15-64 will have barely increased 6.65 percent to 232.9 million.
  

  So, how will revenues ever keep up with costs if comparatively fewer Americans will be of working age as a percent of the overall population — for the rest of the century? We’re already running deficits and the answer is, they won’t.

  Consider, since 1995, the number of older Americans enrolled in Medicaid has only increased on a net basis by 11.6 percent. And yet, the costs for Medicaid nursing home expenditures are up 75 percent.

  If the above ratio holds, the annual tab for long-term care could be as high as half-trillion dollars. And that does not take into account non-seniors who will also be taking advantage of Medicaid.

  The explosion of long-term care costs for seniors will be true whether or not Medicaid expansion under the health care law is ever repealed, since qualifying for Medicaid as a senior predates the law’s enactment in 2010.

  Seniors constitute most of the costs for those long-term services, about 63 percent, CMS data from 2010 reveals. That includes about 71 percent of nursing home expenditures. As the number of Americans 65 years and older using the program doubles over the next 20 years, that figure should begin rising, along with seniors’ share of overall Medicaid spending.

  This puts states in particular in a rather alarming situation. The hundreds of billions that will be spent through Medicaid on long-term care for seniors will be in addition to the hundreds of billions more spent on non-seniors.

  Seniors only accounted for 6.7 percent of the 63.7 million Medicaid beneficiaries in 2010, and yet, made up almost a full quarter of benefits paid — $82.6 billion out of its $311 billion budget.

  And now, with Medicaid expansion, by 2024 alone, the Congressional Budget Office estimates there could be as many as 93 million Americans enrolled in the program as a whole.

  This will get out of control rapidly.

  To a certain extent, the health care law attempts to anticipate some of these challenges and included several financing schemes to boost funding for long-term care for the states. Whether their provision was sufficient, and if it was, whether they are sustainable when the money will have to be borrowed remains very much in question.

  Much of these schemes attempt to control the costs by replacing senior nursing home care to home care, probably on the presumption that there will not be enough beds and non-institutional care is hopefully cheaper. But even there, there are cost concerns.

  A new rule by the Department of Labor enforcing the Fair Labor Standards Act lifted exemptions to the Act that had previously excluded home care workers from minimum wage and overtime pay guarantees. Under the new regime, once the rule takes effect, the costs of home care will necessarily increase — and precisely at the time when demand for those services is about to skyrocket.

  Between the demographic time bomb about to go off – that is, the growth of the elderly population far exceeding the growth of the working age population by several orders of magnitude – and then the weak economy, the huge expansion of entitlements under the health care law, and the dramatic increases of the costs of those entitlements, including for labor, what could possibly go wrong?

  You do the math. And afterward, if you can figure a way out of this mess, please send a note to Congress. Because they probably have no clue what to do. Repealing the health care law’s Medicaid expansion for non-seniors is just the tip of the iceberg.

  

  

  

  

  

• Obama Delivers Statement On Today's Community College Mass Shooting

  The President speaks live about the mass shooting that wreaked havoc at an Oregon community college on Thursday:

  

  

  

  

  

• Oct 2 – Fed's Lacker: Rate Rise In October Possible

  Follow The Market Madness with Voice and Text on FinancialJuice

  EMOTION MOVING MARKETS NOW: 17/100 EXTREME FEAR

  PREVIOUS CLOSE: 21/100 EXTREME FEAR

  ONE WEEK AGO: 22/100 EXTREME FEAR

  ONE MONTH AGO: 9/100 EXTREME FEAR

  ONE YEAR AGO: 7/100 EXTREME FEAR 

  Put and Call Options: EXTREME FEAR During the last five trading days, volume in put options has lagged volume in call options by 16.72% as investors make bullish bets in their portfolios. However, this is still among the highest levels of put buying seen during the last two years, indicating extreme fear on the part of investors.

  Market Volatility:  NEUTRAL The CBOE Volatility Index (VIX) is at 22.55. This is a neutral reading and indicates that market risks appear low.

  Stock Price Strength: FEAR The number of stocks hitting 52-week lows exceeds the number hitting highs and is at the lower end of its range, indicating fear.

   

  PIVOT POINTS

  EURUSD | GBPUSD | USDJPY | USDCAD | AUDUSD | EURJPY | EURCHF | EURGBP| GBPJPY | NZDUSD | USDCHF | EURAUD | AUDJPY 
   

  S&P 500 (ES) | NASDAQ 100 (NQ) | DOW 30 (YM) | RUSSELL 2000 (TF) | Euro (6E) |Pound (6B) 

  EUROSTOXX 50 (FESX) | DAX 30 (FDAX) | BOBL (FGBM) | SCHATZ (FGBS) | BUND (FGBL) 

  CRUDE OIL (CL) | GOLD (GC) | 10 YR T NOTE | 2 YR T  NOTE | 5 YR T NOTE | 30 YR TREASURY BOND | SOYBEANS | CORN

   

  MEME OF THE DAY – BEIJING AFTER VOLKSWAGEN

   

  UNUSUAL ACTIVITY

  APPS Director purchase 127K @ 1.57

  JOY Director purchase 12,200  A  $ 14.77  , 4,346  A  $ 14.8 , 2,854  A  $ 14.81  , 2,265  A  $ 14.82 , 2,435  A  $ 14.83

  Z NOV 30 Puts @ 4.70 on the offer 1600 contracts

  MU Jan 5 Put Activity @ 0.18 on the offer

  BDSI NOV 6 Calls on the offer @ 0.80 1800+

  More Unusual Activity…

  HEADLINES

   

  Markit US Manufacturing PMI Sep F: 53.1 (est 53; prev 53)

  Fed’s Lacker: Rate rise in October possible

  Fed’s Williams: Repeats calls for hike sometime later this year

  Atlanta Fed GDPNow (Q3): 0.9% (prev 1.8%)

  ECB’s Weidmann: ECB should follow steady course

  ESM’s Regling: Greece should not expect big debt writedown

  EG’s Dijsselbloem sees no delay to the Greek aid program

  Spanish PM Rajoy: General election will be on December 20th

  BoJ Official: Little Immediate Need For Additional Stimulus

  EIA Natural Gas Storage Change Sep 25: 98 (est. 100, prev. 106)

  Teva Pharmaceuticals To Buy Rimsa For Approx. $2.3bln

  US auto sales soar, but Volkswagen down

  GM to cut $5.5bln in costs from 2015-2018

  Amazon to Ban Sale of Apple, Google Video-Streaming Devices

   

  GOVERNMENTS/CENTRAL BANKS

  Fed’s Lacker: Rate rise in October possible – WSJ

  Fed’s Williams: Repeats calls for hike sometime later this year – StreetInsider

  Atlanta Fed GDPNow (Q3): 0.9% (prev 1.8%)

  ECB’s Weidmann: ECB should follow steady course – Der Spiegel

  ECB’s Jazbec: No Need To Adjust QE Programme At The Moment – Fiscal Times

  ECB’s Nouy: Global Financial Conditions Remain Volatile In Some Respects – Economic Times

  ESM’s Regling: Greece should not expect big debt writedown – FT

  Eurogroup chief Dijsselbloem sees no delay to the Greek aid program – BBG

  Eurogroup will discuss low interest rate environment – ForexLive

  Snr German Govt Official: Germany expects debate about US rate hike at IMF meeting – Rtrs

  Spanish PM Rajoy: General election will be on December 20th – Rtrs

  Moody’s: EU’s budget management and strong member support underpin credit strength

  SNB Zurbrugg: CHF is particularly overvalued, will continue to intervene as required

  BoJ Official: Little Immediate Need For Additional Stimulus Seen – BBG

  FIXED INCOME

  US Treasuries fluctuated in afternoon trading – BBG

  Spain’s Yields At Four-Month Low After Nation Sells Debt – BBG

  FX

  EUR: EUR/USD hovering near 1.1200, on pre NFP mode – FXStreet

  CAD: USD/CAD recovery capped by 1.3280 – FXStreet

  USD: Dollar slips lower vs. rivals after downbeat U.S. data – Investing.com

  USD: Heads Dollar Wins, Tails It Rises: It’s All Good for Greenback – BBG

  GBP: Sterling’s bright plumage begins to fade – FT

  Currencies Trading Needs Further Cleanup, Regulators Say – WSJ

  COMMODITIES/ENERGY

  U.S. crude inches down as inventory build, Iran deal remain in focus – Investing.com

  Gold futures settle with a loss after a volatile day – MktWatch

  Copper Drops Most in a Week as U.S. Manufacturing Stagnates

  Natural Gas Trading at Seasonal Low from Heavy Surpluses – WSJ

  EIA Natural Gas Storage Change Sep 25: 98 (est. 100, prev. 106)

  EQUITIES

  Wall St dip led by utilities, factory activity slows – MktWatch

  FTSE outperforms Europe but Wall Street fall trims gain – Yahoo

  M&A: Teva Pharmaceuticals To Buy Rimsa For Approx. $2.3bln – FastFT

  M&A: EU regulators query Ball’s proposed Rexam takeover – MktWatch

  M&A: Vivendi has boosted Telecom Italia stake to around 19% from 15.5% – Sources on Rtrs

  AUTOS: US auto sales soar, but Volkswagen down – USA Today

  AUTOS: VW seeks to boost finances to meet emission scandal costs – Rtrs

  AUTOS: GM to cut $5.5bln in costs from 2015-2018 – Seattle Times

  BANKS: JPMorgan Said Mulling $18bln Loans Bid to Rival Goldman – BBG

  BANKS: Bank of England says might raise top-up capital buffer for banks – Rtrs

  TECH: Amazon to Ban Sale of Apple, Google Video-Streaming Devices – BBG

  TECH: Toshiba may axe TV & PC workers, seek partner for nuclear operations-CEO

  ENERGY: Repsol To Cut 6% Workforce Over Next 3 Yrs: Europa Press – ABC

  CONS GOODS: ConAgra to cut 1,500 jobs – MktWatch

  EMERGING MARKETS

  Russia launches fresh strikes in Syria – BBC

   

  World Bank Pres: Shared Prosperity: Equal Opportunity for All

  

  

  

  

  

• These Dramatic Before And After Images Of Syria Demonstrate "Success" Of US Foreign Policy

  One narrative that’s parroted constantly when the US moves to bring about regime change in the Mid-East is that it’s necessary for the good of the people. 

  Typically, the citizenry is characterized as suffering under the brutal oppression of an autocratic regime which is sometimes accused of committing crimes against humanity in order to maintain an iron grip on power and ensure that the seeds of democracy cannot grow.

  Of course this narrative is never wholly true and is rarely even partially so. 

  More often than not, the US has ulterior motives for covertly usurping Mid-East strongmen and the overarching goal is almost always to achieve some narrow geopolitical end.

  This isn’t so much one fringe blog’s opinion as it is a dubious foreign policy tradition for Washington and indeed, it’s almost always readily observable in hindsight. 

  For those who need proof of this, we present the following before and after images of night-time light emissions in Syria:

  

  

  Source: The Economist

  

  

  

  

• Deflation Warning: The Next Wave

  Submitted by Chris Martenson via PeakProsperity.com,

  The signs of deflation are now flashing all over the globe. In our estimation, the possibility of an associated financial crisis is now dangerously high over the next few months.

  As we’ve been saying for a while, our preferred model for how things are going to unfold follows the Ka-Poom! Theory as put out by Erik Janszen of iTulip.com.

  That theory states that this epic debt bubble will ultimately burst first by deflation (the "Ka!") before then exploding (the "Poom!") in hyperinflation due to additional massive money printing efforts by frightened global central bankers acting in unison.

  First an inwards collapse, then an outwards explosion. Ka-Poom!

  We’ve been tracking the deflationary impulse for a while, and declared deflation the winner back in July of this year.

  A Failed Strategy

  What exactly do we mean by deflation?  Back in 2008 the central banks of the developed world, as well as China, had a choice:

  1. admit that prior policies geared towards encouraging borrowing at a faster rate than income growth were a horrible idea, or
  2. double down and push those failed policies even harder

  As we all know, they chose option #2. And so here we are, just 8 years later, with nearly $60 trillion in new debt piled on top of the prior mountain — while GDP grew by only $12 trillion over the same time period:

  

  (Source)

  [Note:  Global nominal GDP is projected to be $68.6 trillion in 2015, virtually unchanged from 2013]

  In other words, instead of saying to ourselves: Hmmm…. it was probably a terrible idea to pile up debt at 2x the rate of income growth, what the world did instead was to double down on that terrible idea and pile on more debt at 5x the rate(!) of nominal GDP growth.

  Talk about not learning from your past mistakes….

  At any rate, what all of that money printing, lower interest rates and new debt creation did was force capital over the globe to look for some place to go. Absent any really good and creative ideas, that money primarily chased yield. It piled into risk assets like stocks and junk bonds, often in bubble-like fashion (meaning, in haste), and without proper due diligence.

  The only way the central bank “strategy” (and we use that word very loosely) could have worked was if very rapid economic growth emerged to justify the accumulated levels of debt, comprised of both old and new borrowing. Central banks were indeed hoping such growth would materialize and lesson the burden of servicing the interest on all that debt.

  But that growth, quite predictably (as forecasted by us among many others), did not emerge.

  Perhaps Japan’s experience should have tipped the central bankers off as to why not.  For several decades now, Japan has served as a warning: too much debt is the malady, not the cure.

  So here we are.  What are we to make of it all?  It's our view that the financial markets are important to monitor because they will signal to us when sentiment has shifted, and let us know in advance that events will unfold at a faster pace.

  Judging from the market action over the past month, we think that shift has happened. And we're increasingly concerned that this next ‘correction’ could be pretty rough for a lot of folks.

  Bright Red Warning Lights

  The global economy is downshifting fast, and there are lots of flashing red warning lights indicating as much.

  Doug Noland has captured the emerging market pain caused by the hot money that is now flooding out of those territories, as well as provided a great explanation of the bubble dynamics in play:

  The Federal Reserve is flailing and global currency markets are in disarray. Notably, the Brazilian real dropped more than 10% in five sessions, before Thursday’s sharp recovery reversed much of the week’s loss. This week the Colombian peso dropped 3.0%, and the Chilean peso fell 3.1%. The Mexican peso dropped 1.9%.

   

  The Malaysian ringgit sank 4.5% for the week, with the South Korean won down 2.7% and the Indonesia rupiah losing 2.2%. The Singapore dollar fell 1.8%. The South African rand sank 4.4% and the Turkish lira fell 1.4%.

   

  Notably, market dislocation was not limited to EM. The Norwegian krone was hit for 4.4%, and the Swedish krona lost 2.0%. The British pound declined 2.3%. The Australian dollar also lost 2.3%.

   

  The global Bubble is bursting – hence financial conditions are tightening. Bubbles never provide a convenient time to tighten monetary policy. Best practices would require central bankers to tighten early before Bubble Dynamics take firm hold. Central bankers instead nurture and accommodate Bubble excess. It ensures a policy dead end.

   

  As the unfolding EM crisis gathered further momentum this week, the transmission mechanism to the U.S. has begun to clearly show itself. While “full retreat” may be a little too strong at this point, the global leveraged speculating community is backpedaling. Biotech stocks suffered double-digit losses this week, as a significant Bubble deflates in earnest. It’s also worth noting that the broader market underperformed.

  (Source)

  What does it mean when we see currencies in retreat across the globe?  It means that the hot, speculator money is rushing out of weaker economies and back towards the stronger center.  This is consistent with a liquidity crisis, one where all the borrowed money used to spark all those heady asset gains and falling yields on the way out do the exact opposite on the way back.

  And Doug is exactly right – there’s never a good time to pop a bubble.  So the central bankers just sit, paralyzed, afraid to even raise rates by a token amount for fear that the daisy-chain of global bubbles will burst as a result. They needn’t fear: the bubbles will burst no matter what the Fed, et al., does.

  A credit default swap (CDS) is a bit of insurance you can buy if you own a bond and are worried that the issuer may default on it.  In a stable climate, the cost of that insurance (measured in percentage points above the stated yield on that debt) is pretty flat. It's usually close to the yield of the bond in question.

  So you might have to pay 1% to 2% (i.e. 100 to 200 basis points) above the yield on, say a Brazilian ten year bond, to insure it against a default.  As things begin to break down and become less certain, that cost will rise.

  Now take a look at this chart of recent emerging market CDS 'spreads':

  

  (Source)

  See those CDS ‘spreads’ blowing out to the upside? That’s the sort of thing I was tracking in 2008 that gave me a clear, early warning that things were about to fall apart.  While these levels are not (yet) flashing the same level of danger that we are seeing in the CDS paper for Glencore (which is almost certain to go bankrupt now), or for US shale drillers (tons of bankruptcies coming there, too), these are pretty serious warning signs to see in sovereign debt.

  Why would the sovereign debt of Russia, Turkey, Brazil, and Malaysia be spiking right now?  Because the hot money is flooding out of those countries. There's now an elevated risk that they may default on their bonds in the future.

  These emerging market countries are being squeezed from every direction. But the worst pain is being experience by those that borrowed heavily in dollars (or other stable currencies).  From the WSJ (Sept 29), we see the magnitude of the predicament for companies located in EM nations:

  Developing-country firms quadrupled their borrowing from around $4 trillion in 2004 to well over $18 trillion last year, with China accounting for a major share.

  Now, prospects in industrializing economies are weakening fast even as the U.S. Federal Reserve is getting set to raise interest rates for the first time in nearly a decade, a move that will raise borrowing costs around the world.

   

  The burden of 26% larger average corporate debt ratios and higher interest rates come as commodity prices plummet, a staple export for many emerging-market economies.

   

  Compounding problems, many firms borrowed heavily in dollars. As the greenback surges against the value of local currency revenues, it makes repaying those loans increasingly difficult.

  (Source)

  So the afflicted countries are going to see vastly weaker exports, plunging currencies, and their local corporations unable to pay off dollar-denominated loans — on borrowing that ballooned from $4 trillion in 2004 to over $18 trillion just 11 years later.  It’s an amazing statistic, one of many fostered by a cluster of central banks that know everything about blowing bubbles but nothing about ending them.

  The punch line from the above article is this: “That massive debt build-up means it is “vital” for authorities to be increasingly vigilant, especially to threats to systemically important companies and the firms they have links to, including banks and other financial firms, the IMF said.”

  Decoded, that means that $18 trillion is a big number. If even a small portion of that goes into default, it could easily drag down whole swaths of the developed world’s financial corporate structure.  A systemic crisis that would begin on the edge but rapidly spread to the center.

  Well, based on the DDBAX ETF which holds bonds priced in local currencies, we can get a sense of the pain those EM companies are feeling which have dollar denominated loans, but conduct business in their local currency:

  

  Ouch!  Based on the above chart, the past year has been painful indeed for those emerging market corporations and governments. No sign of a bottom yet either.

  Not So Fast There….

  One so-called ‘bright spot’ in the world economy is the US, which supposedly is doing better than everyone else.  As you know, I consider US GDP statistics to be nearly useless because of all the statistical tricks and gimmicks that are now deployed (such as now counting ‘intangibles’ to go along with Owner Occupied Rent which records the price value of people not paying themselves rent, etc.,) to make things look better than they are.

  So I’m having trouble believing that the US economy is doing well when our major trading partner to the south is struggling so much due to a huge drop drop in exports:

  Mexico factory exports slump by most in over 6-1/2 years in Aug

  Sept 25, 2015

   

  (Reuters) – Mexico's factory-made exports slumped in August by the most in more than 6-1/2 years after uneven growth in the first half of 2015, data showed on Friday, while consumer imports rose.

   

  Manufactured exports sank 7.2 percent in August compared with July, falling back after two months of gains, the national statistics agency said in a statement. It was the biggest month-on-month drop since December 2008, data showed.

   

  Mexico exports mostly manufactured goods like cars and televisions and about three-quarters are sent to the United States.

  (Source)

  It’s hard to imagine that the US economy is doing fine when a major trading partner who exports 75% of its finished product to the US is experiencing a deep export slump.

  But it’s not just Mexico that's seeing a big decline in export activity:

  For the first seven months of 2015, U.S. exports dropped 5.6% to $895.7 billion. The value of South Korean exports shrank a revised 14.9% in August from a year earlier, the sharpest fall in six years, as shipments to China dropped. Chinese imports in August fell 13.8% in dollar terms from a year earlier, after an 8.1% decrease in July.

  (Source – WSJ)

  If this keeps up, 2015 will see the worst global trade performance since…wait for it…2008.  For the US, 2015 will be the first year that exports have declined since the financial crisis.  Ditto for a number of other countries.

  Beyond exports, the surveys of US manufacturing and service sector activity are also flashing recession warning signs.  In fact, the manufacturing survey has only been this low in the past during prior recessions. Maybe this time is different?

  

  

  (Source)

  On the plus side for the US: reasonably robust housing activity, low initial claims for unemployment, and growing income and expenditures. But the data for some of these is suspect (nearly 100 million working-age adults are not counted in the workforce), and in other areas, not robust enough to hang too many hopes on.

  Add it all up, and there are a number of signs that not only is the US economy is far from robust, it may even be teetering on the verge of a recession. But the global economic landscape is decidedly tilted towards contraction, not expansion.

  Why is all this important?  Because seeing these signs early enough gives us a better chance to mentally, financially, and physically prepare for the next shock.  The press does a very good job of constantly painting everything in a rosy light, and that’s fine, but it’s not very helpful if it also misleads.

  Lots of people are woefully unprepared for what’s coming next. For many it will be a shock.  Not because they couldn’t see it coming years in advance and made their own mental and financial adjustments on their own terms, but because they wouldn’t.  Preferring to avoid an unpleasant truth they put it out of sight and out of mind, hoping that somehow things would work out in their favor.

  In Part 2: From Deflation To Hyperinflation, we detail out the likeliest progression of the unfolding deflationary rout and the inevitable tsunami of money printing that the central banks will respond with, unleashing the final hyperinflationary chapter.

  Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

   

  

  

  

  

  

• In Latest Sign Of EM Chaos, Turkey's FX Reserves Fall Below Key Threshold Ahead Of Pivotal Elections

  One of the key things to understand about the veritable meltdown that’s unfolded across emerging markets is that there’s more to the story than the headline risk factors. 

  That is, while the list of proximate causes that includes a decelerating China, collapsing commodity prices, and uncertainty over when or even if the Fed will hike goes a long way towards explaining the carnage that’s unfolded across EM, each country has its own set of unique circumstances to grapple with. Indeed, the idiosyncratic political risks playing out across emerging economies have taken center stage as Brazil attempts to navigate congressional gridlock, Malaysia struggles with the 1MDB scandal, and Turkey faces new elections in November.

  While there’s no question that the political situation in Brazil is particularly troubling, it would be difficult to imagine a more precarious scenario than that which exists in Turkey, where President Recep Tayyip Erdogan has managed to subvert the democratic process by starting a civil war, and thanks to the strategic significance of Incirlik, the effort is co-sponsored by the US and NATO.

  Of course extreme political uncertainty, a bloody civil war, and an unfolding proxy war just across the border do not inspire much confidence, which helps to explain the fact that Turkey’s FX reserves have now fallen below $100 billion for the first time since 2012:

  

  And here’s an updated look at the lira which is in the midst of a rather epic decline (which threatens to destabilize inflation) thanks to everything noted above combined with a central bank that either i) doesn’t understand the gravity of the situation, or ii) is loathe to hike rates going into the election:

  

  If you think it’s bad now, just wait until November. If AKP doesn’t secure an absolute majority there’s no telling how Erdogan will react and if Ankara moves to nullify yet another democratic election by intentionally stirring up the PKK, you can expect outright chaos. We close by noting that data out today shows Turkey’s manufacturing PMI fell for a second straight month in September and we also think it’s worth highlighting the following excerpt from The Guardian which provides a bit of insight into what’s in store going forward if Erdogan doesn’t get his way:

  Ahmet Hakan, a columnist for Turkey’s leading secular Hürriyet newspaper and a presenter on broadcaster CNN Turk, was followed home from the television station by four men in a black car late on Wednesday, before being assaulted near his residence, according to the Hürriyet editor-in-chief, Sedat Ergin.

   

  “We see that it was an organised, planned attack,” Ergin was quoted as saying. Hakan was treated for a broken nose and ribs, the newspaper said.

   

  The attack comes just weeks after prosecutors launched an investigation into the paper’s owner, Do?an Media Group, for alleged “terrorism propaganda“.

  

  

  

  

  

• It's One Indivisible System: Empire, The State, Financialization, & Crony Capitalism

  Submitted by Charles Hugh-Smith of OfTwoMinds blog,

  The great irony is what's unsustainable melts into thin air no matter how many people want it to keep going.

  Disagreement is part of discourse, and pursuing differing views of the best way forward is the heart of democracy. Disagreement is abundant, democracy is scarce, despite claims to the contrary.

  If you think you can surgically extract Empire from the American System, force the State to serve the working/middle classes, end the stripmining of financialization, limit crony capitalism/regulatory capture and get Big Money out of politics–go ahead and do so. I'm not standing in your way–go for it.

  But while you pursue your good governance, populist, Left/ Right /Socialist/ Libertarian, etc. reforms, please understand the system is indivisible: the Deep State, the Imperial Project (hegemony and power projection), the State, finance in all its tenacled control mechanisms (greetings, debt-serfs and student-loan-serfs), crony capitalism /regulatory capture, money buying political influence, media propaganda passing as "news", and the evisceration of democracy (something untoward could happen if the serfs could overthrow the Power Elite at the ballot box–can't let that happen)–it's all one system.

  Should any one organ be ripped from the body, the entire body dies. The entire system defends each subsystem as integral as a matter of survival. As a result, the naive notion that big money can be excised with only positive consequences is false: restoring democracy places the entire system at risk of implosion.

  No more bread and circuses, no more Social Security checks, no more state employee pensions–it all melts into air if any subsystem stops doing its job.

  The system is interdependent. Each subsystem needs the others to function. I drew up a chart of the major components (but by no means all) of the system:

  

  The system is a machine in which each gear serves the whole. So go ahead and try to "reform" the system by extracting whatever gear you don't approve of: the Deep State components, the Security State organs, the Federal Reserve, cartels/monopolies enforced by the State, the suppression of democracy, crony capitalism, whatever.

  The machine will resist your "reform" to the death because should you succeed, the machine will implode. Take out the financialization gear and the financial system collapses.

  So go ahead and reform to your heart's content. Go ahead and believe the system is reformable, if it makes you feel better. Vote for Bernie or The Donald or whomever. Go ahead and disagree with me. Prove me wrong. Prove the State really, really, really wants to serve the working/middle class rather than the Empire that it is. Pursue your Left/ Right/ Socialist/ Libertarian fantasies of righting the Imperial Project by ripping the gears out of the very center of the machine.

  It doesn't work that way. We can't remove the gears we find distasteful. Either the machine grinds on and we get our share of the swag–bread and circuses, corporate welfare, State jobs and pensions, Medicaid and Medicare, and all the rest of the immense swag of hegemony and the Imperial Project–or the system implodes and all the swag melts into air.

  The great irony is what's unsustainable melts into thin air no matter how many people want it to keep going.

  But go ahead and disagree. It's your right, by golly. Go ahead and try to "reform" the system and see how far you get.

  

  

  

  

  

Digest powered by RSS Digest