The only time I recall the markets and the real world telling such divergent narratives than now is just before the dot-com crash of the late 90s. At that time, it was the public markets that exuded a misplaced optimism built on the house of cards called dot-com calculus. Now, it seems the real world pain has dramatically diverged from what the holy trinity of The Data, The Fed, and The Yield Curve are preaching. Both can’t be right; this is how it all goes wrong.

If we pick up where we left off in my last post in mid-April, I partly focused on the Chinese futures price in construction materials that were grossly overvalued and driven by pure speculation. Chinese re-bar, steel, and concrete futures all have crashed by roughly 30% since then, and even the Chinese government had to intervene in the markets at the end of April to curb speculation. Just last night ( May 22, 2016, local Beijing time), iron ore and rebar (used in high-rise construction) was down 7% in a single trading session.

However, speculation doesn’t simply appear out of nowhere. In the first quarter of this year, China created a jaw-dropping one trillion in new debt. That is the entirety of US quantitative easing in all of 2013. Where does that cash go? Perhaps the Chinese “student” that paid 31 million in cash for a Vancouver home[1] might tell us. New credit created to prop up asset prices is fleeing China anyway it can and right now that is in Dollar based (or close to Dollar) assets in any form.

Why? Overnight on May 17th, China devalued its currency (changed the peg) to the lows of the year. Chinese debt to GDP is racing to all-time highs and the unrecoverable debt balances within China may dwarf that of the subprime crisis – we simply don’t have the transparency to know but the people who do, members of the ruling party, are floating the life rafts.

It was during this bright and polished environment (mid-May 2016) Federal Reserve members Dudley and Lockhart struck a hawkish tone by putting a June hike back on the table for US rates. Now, the 2s30s yield curve is now the flattest it has been since the end of 2008, jobless claims today (05/19) are worse than expected and are sitting at quarterly highs, and the Philly Fed also bled out after being crushed by a dearth of new orders.

Shall I continue? Venezuela is on the brink of a coup d’état and is currently a war zone while Brazil teeters on default (U.S. Rate Hikes: “One and Done” in 2016) – and all while, the port-in-a-storm strength of the dollar will force a “real devaluation” by China. In the United States, headline unemployment sits at 5% only because millions of job hunters have given up and, statistically, dropped out of the sample pool.

This doesn’t even begin to get into negative rates around the world. If you would have told me five years ago that this much debt of industrialized nations would trade at negative yields, I could only have assumed that a zombie apocalypse had occurred or a particularly virulent strain of the medieval Black Death was hopscotching across international borders like the flapping doors of an old western saloon.

blog 8 1

Source: Tradeweb &

More? How about Saudi Arabia? I believe they have 18 months of cash left before that state is structurally insolvent. They currently are unable to pay even the most basic of bills and are scrambling to publicize plans to pivot their economy to non-oil based revenues all while shoveling unheard of levels of debt out the back door in an unprecedented cash grab. Both Saudi and Iran will pump oil at infinity in a balance sheet proxy war that will cap the price of oil, probably for my lifetime. I can only image a conversation in the 1820s London when someone began to think, “You know, maybe all this timber isn’t as important as it used to be”. We are now there for oil.

More? How about Caterpillar hitting an unheard of string of losses, the crush of Silicon Valley layoffs [2], or the startup unicorn Theranos entire value being reduced to what they can sell the URL for? [3] (Free Caterpillars and Slaughtered Unicorns). Don’t begin to believe the wealth evaporation in the la la land of Silicon Valley has no impact in the real world they are so disconnected from. The wealth effect is real and as paper billionaires become freshly unemployed, the collective gasp as investors open their monthly statements will only get louder.

blog 8 2

Source: Caterpillar


blog 8 3

Source: DataFox

So where does this leave us? What was so clear in December & January has now come to pass. The S&P has dipped into negative territory for the year and has more downside to go as we run the gauntlet of global risks that could reveal that central banks truly, really, have few policy tools left.

The United State’s monetary policy toying with a hike right now is like a designated driver that thinks “What’s the worst that could happen with one drink?” It’s probably OK to think about but never a good idea in practice. Real America is struggling under the crushing weight of addiction [4], under or no employment, existential levels of debt, in an economy that offers little to no hope. NYC and DC are fine and those lucky enough to only frequent that barbell of an echo chamber are most likely to say, “June is on the table.” Meanwhile in the Eurozone, millions flood the shores, the UK wants out, and trillions of dollars are literally paying to get notional back five years from now for 95 cents on the dollar.

“How it all goes wrong” just might be the understatement of the decade.