Jul 07/15 – When I see a bubble…

2015-07-07 8am EDT  |  #China #ECB #Greece #SCHOMP #Soros

My younger cockier self used to try to short every bubble out there. I used to rail against all the stupid prices, the parabolic moves and the ignorant performance chasing. But the last five years have been tough on me. Bubbles are so prevalent, with so many asset prices going to levels that make no sense. German 10 year bunds at 0.05%? How do you account for that sort of stupidity? The Central Banks are in the driver’s seat of these latest manias, and in some ways, they are even more delusional than the maddest crowd.

As I have gotten older, and the tiniest bit wiser (although my wife says it is barely noticeable), I have begun to appreciate the grizzled veterans who can identify a bubble, and instead of fighting it, simply join in on the rise. George Soros is the perfect example of a market wizard who instead of trying to fight the bubble trend, climbs aboard for the ride.

There are lots of pundits who are proclaiming the Chinese equity market to be a massive bubble. I can’t say I disagree. Any equity index that more than doubles in one year is most likely a little bubbly. When you see banana stand guys trading stocks from their booths, you know the risks are high.

Yet the past three weeks have been tough on the Chinese stock market. The SHCOMP has plummeted over 30% during this period.

This sickening decline has retraced more than 50% of the recent rise.

I will not bore you with all the terrible charts of Chinese economic activity. We all know most economic indicators are headed into the toilet. There is precious little to be optimistic about. It is quite easy to make the case the Chinese stock market was a massive bubble that is now bursting.

The Chinese government is desperately trying to cushion this decline. They have cut the required reserves, halted IPOs, and even instituted rules that allow brokers to use real estate as margin.

Most market observers are viewing these moves as frantic flailing by a panicky government. From a Bloomberg article:

"It does come across as relatively desperate," said Wei Hou, an analyst at Sanford C. Bernstein & Co. in Hong Kong. "Globally, illiquid assets such as real estate are not accepted as collateral as they are very hard to liquidate."

However, I would like to humbly suggest maybe the bears have become a little too sure of themselves. Don’t forget the sharpest corrections occur in bull markets, not bear markets. This sort of large quick decline is more typical of a correction as opposed to the start of a prolonged bear market.

Remember the 1987 crash? Lots of investors mistakenly believed it was the start of a secular bear market. Yet it proved to just be another opportunity to buy the dip.

What if the Chinese stock market correction of the last three weeks is more of a 1987 style crash instead of a 2008 roll over?

The PBOC has already taken steps to stabilize the stock market decline. They have shown a willingness to ease policy to support their stock market (and their economy). The Chinese still have lots of room to stimulate through easier monetary policy, as opposed to many other Western countries that are zero bound.

I have not bought any Chinese stocks yet, but I am watching for an opportunity to dip my toe into the water. Don’t misconstrue my relative bullishness as an indication that I do not believe Chinese stocks to be in a bubble. I definitely think they are a bubble. But what asset class isn’t a bubble these days? I am just fed up trying to fight all these Central Banks, and the PBOC is probably the biggest bad boy of them all in terms of getting asset classes to where they want them to go. Who am I to fight them? Hopefully this is a sign of maturity on my part and not the first signs of trading dementia.

A Grexit is coming…

The more I reflect on the Greek situation, the more convinced I become the Greek government is fully aware there will be no deal. They couldn’t sell a Euro exit to the Greek people, so they adopted the hardest of negotiating stances with the idea that if the Europeans fold, then it would be a win, and if no deal is to be had, then it is also a win because the Greeks could default while blaming the Germans.

The always insightful Martin Enlund from Nordea has recently been highlighting the troubled relationship between the EU and the Greeks.

Timothy Geithner: "EU leaders were obsessed with crushing terrible Greeks"

Leaked transcripts of discussions of Tim Geithner, the former US treasury secretary, published in the FT's Brussels blog reveal that EU leaders were obsessed with punishing Greece at the height of the Eurozone crisis in 2010.

The 100 pages of transcripts obtained by Peter Spiegel were of interviews Geithner gave to assistants preparing his book.Stress Test – in which he revealed that in 2012 German Finance Minister Wolfgang Schaeuble had presented him with a plan to kick Greece out of the eurozone . This, he said, would appease German voters and terrify Europe.

In the transcripts, Geithner recalls a meeting of a group of seven finance ministers in the remote Canadian town of Iqaluit - the first time he met his German counterpart Wolfgang Schuble - held in February 2010:

"The Europeans came into that meeting basically saying: We're going to teach the Greeks a lesson. They are really terrible. They lied to us. They suck and they were profligate and took advantage of the whole basic thing and we're going to crush them'".

No wonder the Greeks are so hostile towards the Germans. Some of you might argue the Greeks got what they deserved. I don’t really care who is at fault. I am only interested in what will happen.

I saw an interesting statistic the other day about the extent of the economic contraction in Greece. The reporter said something to the effect that there has been much worse declines, and that the Greece situation was not that bad.

Have a good look at this chart. All the contractions that were worse than the recent Greek economic decline were either during war time or the result of the Great Depression. I don’t see how this is anything but a terrible humanitarian disaster.

And it’s not getting any better any time soon. I had thought the ECB might ride to the rescue for the short term liquidity of the Greek economy, but yesterday they increased the haircuts for Greek debt. This was in essence an increase in the margin required by the Greek banks. Instead of helping out the Greeks, they kicked them when they were down.

But I guess this should come as no surprise. Martin has also been reminding us all of the hard line the ECB took with the Irish in 2010. From Business Insider:

A leaked letter published by The Irish Times on Thursday shows the European Central Bank (ECB) threatened in November 2010 to pull emergency funding from Irish banks if the Irish government did not apply for a bailout.

The letter is significant because the ECB previously held that Ireland voluntarily asked for a bailout, effectively declaring that the state was failing. That has now been shown to be false.

It shows the ECB demanded not only that the Irish government seek a bailout, but also that Irish taxpayers guarantee the emergency funding to its banking sector in order to receive central bank support. The letter in evidence of the ECB straying into government policy of member states as early as 2010.

I do not see how a Grexit can be avoided. The Europeans and the ECB are turning the screws to the Greeks, and I do not think that Tsipras will fold given his recent overwhelming win.

The market is still relatively calm, but I as one of my favourite twitter guys recently remarked:

The shit has yet to hit the fan. Don’t assume that because the markets are not freaking out that everything will be fine.

Bill Fleckenstein summed it up perfectly:

“And that is actually a bad thing: for the less contagion we and [the ECB and EU ministers] see on our screens due to the ECB or other sand-bagging markets, the more time European creditor nations, the troika and so forth, may feel they have to negotiate with [Greece's left-wing party] Syriza. They are wrong, there is no time left, and if Greece falls out of the euro, then why would anybody want to keep money in a Spanish, Portuguese, or Italian bank.”

It is quite fitting that outside the ECB they recently had to make repairs to the Euro statue:

I suspect before this is all through, those repairmen will be needed for not only the Euro statue, but for the real Euro as well… Be careful out there…

Thanks for reading,

Kevin Muir

the MacroTourist