Commodities Are Screaming Trouble But the Fed Isn’t Listening

SPDR S&P Metals & Mining Exchange Traded Fund (Red), Freeport-McMoRan (Blue), and BHP Billiton (Yellow) Charts for Past Year

SPDR S&P Metals & Mining Exchange Traded Fund (Red), Freeport-McMoRan (Blue), and BHP Billiton (Orange) Charts for Past Year


By Pam Martens and Russ Martens: July 31, 2015 

The commodities slump has accelerated this past month with gold now trading at five-year lows and the U.S. crude benchmark, West Texas Intermediate (WTI), down 19 percent in just the past month, 49 percent on the year, and 57 percent in the past two years. In early morning trade, WTI is at $47.82 versus $110 two years ago.

Minutes of the Federal Reserve’s Open Market Committee meeting on December 16 and 17 reveal that the Fed was expecting an upturn in oil prices this year, writing: “…inflation was projected to reach the Committee’s objective over time, with longer-run inflation expectations assumed to remain stable, prices of energy and non-oil imports forecast to begin rising next year, and slack in labor and product markets anticipated to diminish slowly.”

CNN Money is reporting this morning that major iron ore or metals exporting countries like Peru (copper), Chile (copper), South Africa (iron ore and gold), Australia (iron ore and gold), Brazil (iron ore), Zambia (copper), and Democratic Republic of the Congo (metals and crude oil) are experiencing a serious economic impact from the plunge in commodity prices over the past year.

There are three major culprits behind the global glut and commensurate decline in the price of industrial commodities. The growing gap in income and wealth equality worldwide is aggravating the consumers’ inability to boost economic activity; China is the world’s largest importer of industrial commodities and it’s experiencing both an economic slowdown and a loss of investor confidence as a result of wild gyrations in its stock market and unprecedented government props to prevent a collapse; and, finally, Fed Chair Janet Yellen’s incessant chatter about an upcoming hike in U.S. interest rates has elevated the U.S. Dollar, putting more downward pressure on commodity prices.

Most industrial commodities are priced in U.S. Dollars, making them more expensive as foreign currencies decline in value. According to the Bloomberg Dollar Spot Index, the U.S. Dollar is now trading at its highest level since 2004 versus 10 other major currencies.

The rout in foreign currencies is now forcing some countries to raise interest rates to defend their currencies at one of the most inopportune times in terms of economic weakness. Bloomberg Business is out with the following disturbing news this morning: “All of the 24 most-widely-traded emerging-market currencies tracked by Bloomberg have weakened over the past month except for the Hungarian forint. An index of their exchange rates has dropped 8 percent this year to the lowest on record in data going back to 1993. The current pace of declines would make this the worst year since 2008.”

Growing comparisons to the conditions leading to the financial crisis in 2008 are causing investors to rethink their exposure to roller coaster markets and the potential for liquidity air pockets. That lack of confidence is being exacerbated by a growing feeling that the Fed is either living in a fantasyland of economic optimism or simply talking its book to support the U.S. Dollar and prevent a capital flight.

One thing is for sure, as the above chart of metals and mining stocks shows, Ms. Yellen is presiding over a lot of pain in a broad number of arenas.

Wall Street’s Secret Dividend from the Fed May Go to Fixing Potholes

By Pam Martens and Russ Martens: July 29, 2015

Photo of the Trading Floor at the New York Fed (Obtained by Wall Street On Parade from an Educational Video  Despite Stonewalling by the New York Fed)

Photo of the Trading Floor at the New York Fed (Obtained by Wall Street On Parade from an Educational Video Despite Stonewalling by the New York Fed)

Your humble editor and publisher of Wall Street On Parade might have had a little something to do with a growing mutiny in Congress. Back on November 4, 2012 and again on July 25, 2013, we blew the whistle on an obscene, secret entitlement program between the Fed and the too-big-to-fail banks: a century old program where every year, boom or bust, despite the overall level of interest rates in the markets, the Fed pays out a risk-free, guaranteed 6 percent dividend to its member banks. (All Fed member banks get the dividend but the lion’s share goes to the biggest Wall Street banks because their capital dwarfs all other banks.)

Now, after more than a hundred years, there’s a plan in Congress to shrink that payout to 1.5 percent and fix our crumbling roads with the savings. Only banks with $1 billion or more in assets would be affected.

The Federal Reserve mandates that its member banks subscribe to “stock” in an amount equal to 6 percent of their capital and surplus.  The banks have to post half that amount with the Fed upon becoming a member; the other half is subject to being called upon. The deposited capital translates into a corresponding share of “stock” in one of the 12 regional Fed banks. (The biggest Wall Street banks, of course, prefer holding their shares in their crony New York Fed.) The “stock” then pays out the 6 percent dividend to shareholders, meaning the banks.

If the bank had a hand in crashing the economy twice in the past century, say in 1929 and again in 2008 – like JPMorgan and Citigroup – it gets an extra bonus: its 6 percent dividend is tax-exempt. That’s because the statutes say that if the bank’s shares in the Fed were acquired prior to March 28, 1942 the bank doesn’t have to pay corporate taxes on it. JPMorgan’s roots reach into the eighteenth century while Citibank, part of Citigroup, traces its founding to the City Bank of New York in 1812. CEOs of both banks were shamed before Congress in the 1930s for their role in the crash of ’29 and again following the 2008 Wall Street crash.

But these two banks achieved even greater ignominy in May of this year: both pleaded guilty to a felony charge, admitting that they participated in a banking cartel to rig foreign currency trading. In other words, the Fed, the regulator of these banks, is paying this lavish 6 percent dividend to admitted felons while U.S. college students are going without food and heat and opting for prostitution to pay their more than $1 trillion in student debt – much of it saddled on their backs by these same banks.

In our 2012 article, we suggested the following:

“These ridiculously high dividends relate directly to our national deficit and the current debate on shared sacrifices. Any excess earned by the 12 Federal Reserve Banks after these dividends are paid is turned over to the U.S. Treasury and can be used to retire government debt. If the dividends were cut to 1 percent, commensurate with what other investors are receiving, billions more would be available to the Federal government.  Ending the tax subsidy on the dividends would add billions more to government coffers over time.”

The current proposal before Congress to shrink the dividend from 6 percent to 1.5 percent is estimated to raise $17 billion over the next ten years. The concerns coming from community banks could be easily remedied by amending the requirement to include only banks with $10 billion or more in assets. (The biggest Wall Street banks hold $1 to $2 trillion in assets.)

Of course, the American Bankers Association was out quickly with its own lobbying effort, writing to Congress:

“We strongly urge you to oppose this proposal. As Senate Banking Chairman Richard Shelby has pointed out, there is absolutely no connection between the Federal Reserve System and the funding for the Highway bill. Furthermore, during testimony before the Senate Banking Committee on July 16th, Federal Reserve Chair Janet Yellen stated: “I would say that this is a change to the law that could conceivably have unintended consequences and I think it deserves serious thought and analysis.”

The ABA should know better than to make such a dumb, easily discredited statement. America’s crumbling infrastructure is a direct result of our Nation’s debt burden which limits what we can spend to maintain a safe, modern highway system. That massive debt directly results from the stimulus spending necessitated by these same Wall Street banks creating the worst economic collapse since the Great Depression in 2008-2009 and the ensuing subpar 2 percent growth over the past five years.

It’s long past the time to end this big-bank entitlement program.

When China Sneezes, the U.S. Stock Market Could Catch a Bad Cold

By Pam Martens and Russ Martens: July 28, 2015

DragonAccording to the Office of the U.S. Trade Representative, “China was the United States’ 3rd largest goods export market in 2013.” That’s the latest year that data is available. The total of U.S. exports to China in 2013 reached $122.1 billion, a 10.4 percent increase over 2012.

The top categories of goods that we export to China are: agricultural products, $25.9 billion; aircraft, $12.6 billion; machinery, $12.2 billion; electrical machinery, $11.4 billion; and vehicles, $10.3 billion.

According to a March report from FactSet, “companies in the S&P 500 in aggregate generate about 10 percent of sales from the Asia Pacific region, most of which comes from China and Japan.”

On Monday, China’s Shanghai Composite Index fell 8.48 percent (it was off another 1.7 percent at the close on Tuesday, closing at 3,663). From a June 12 high of 5,166, the Shanghai Composite is now off 29 percent in less than two months and the roller coaster ride which had seen as much as $4 trillion in investor losses earlier this month is spilling over into U.S. markets. Many S&P 500 stocks have far greater sales exposure to China than 10 percent.

According to Sue Chang, a MarketWatch reporter using data from FactSet, 52 percent of Yum Brands sales come from China; Qualcomm derives 48 percent;  Micron Technology 40 percent; and Texas Instruments 32 percent.

Along with the troubles in China, the U.S. economy is facing a rash of equally serious headwinds. Canada has now entered a technical recession with two back to back quarters of contraction this year. Canada is the number one export market for U.S. goods, buying $312 billion from the U.S. in 2014 or 19.2 percent of all U.S. exports.

The U.S. also has the headwind of a stronger U.S. Dollar, making our exports less competitive than those from countries with depressed currencies. And, quite significantly, capital expenditures from U.S. energy companies have taken a bruising because of the dramatic plunge in crude oil prices. As we reported in December:

“There is a mushrooming false narrative taking over the business airwaves: lower oil prices lead to lower prices at the pump which put more cash in consumers’ pockets which will lead to a more robust economy in the United States in 2015.

“Yes, there are certainly lower prices at the pump. Yes, that gives consumers more disposable income. But it will decidedly not lead to a more robust economy in the United States for very long…If this price collapse were happening in just crude oil, it could be shrugged off as a supply glut problem attributable to growing shale production in the U.S. and over production among OPEC members. But other industrial commodities are in freefall as well.”

And in January we reported on the impact from energy companies scaling back capital goods expenditures:

“Television pundits and business writers who are relentlessly pounding the table on how cheaper home heating oil and gas at the pump is going to provide a consumer windfall and ramp up economic activity have a simplistic view of how things work.

“Oil-related companies in the U.S. now account for between 35 to 40 percent of all capital spending. Announcements of sharp cutbacks in capital spending and job reductions by these companies create big ripples, forcing related companies to trim their own budgets, revenue assumptions, and payrolls accordingly.

“The announcements coming out of the oil patch are picking up steam and it’s not a pretty picture. Last week Schlumberger said it would eliminate 9,000 jobs, approximately 7 percent of its workforce, and trim capital spending by about $1 billion. Yesterday, Baker Hughes, the oilfield services company, announced 7,000 in job cuts, roughly 11 percent of its workforce, and expects the cuts to all come in the first quarter. Baker Hughes also announced a 20 percent reduction in capital spending. This morning, the BBC is reporting that BHP Billiton will cut 40 percent of its U.S. shale operations, reducing its number of rigs from 26 to 16 by the end of June.

“When Big Oil cuts capital spending, we’re not talking about millions of dollars or even hundreds of millions of dollars; we’re talking billions. Last month, ConocoPhillips announced it had set its capital budget for 2015 at $13.5 billion, a reduction of 20 percent.”

In less than two years, West Texas Intermediate, the U.S. benchmark crude oil, has dropped in price from $110 to $47.26 this morning, a stunning collapse of 57 percent.

Against this revealing backdrop on the health of the global economy, Fed Chair Janet Yellen continues to suggest that the U.S. economy is likely to normalize at any moment to the point that the Fed will have to hike interest rates to dampen an overheating economy. Welcome to Wonderland.

Chinese Stocks Crash Overnight; Will We See Another “Glitch” in New York

By Pam Martens and Russ Martens: July 27, 2015

Shanghai's Bull Statue on Its Bund Waterfront (left); Bull Statue in Lower Manhattan (right)

Shanghai’s Bull Statue on Its Bund Waterfront (left); Bull Statue in Lower Manhattan (right)

Despite unprecedented efforts by the Chinese government to stem the rout in the Chinese stock market that had shaved as much as $4 trillion from share prices before the government’s interventions this month and last, the Shanghai Composite closed down 8.48 percent today at 3,725.558.

The overnight rout has raised speculation in some quarters as to whether we are going to see another “glitch” on the New York Stock Exchange today similar to that of July 8 in the midst of another Chinese stock market tumble. As we reported at the time:

“Yesterday, beginning at 11:32 a.m. and for the next three hours and forty minutes, the iconic New York Stock Exchange shuttered trading in all of its listed securities. The Exchange said it had experienced an internal glitch.

“Unknown to most Americans, some of those shuttered stocks on the New York Stock Exchange were Chinese stocks and among the largest capitalized companies in the world. More than 100 Chinese companies trade on U.S. stock exchanges as American Depository Receipts (ADRs) and almost 200 Chinese company ADRs trade over-the-counter in the U.S. (Individual shares are referred to as ADS, American Depository Shares.) Last year, Thomson Reuters estimated the market value of Chinese companies listed on just the New York Stock Exchange and Nasdaq Stock Market at more than $1.4 trillion.

“With the Chinese stock market rupturing over the past week and trading in more than a thousand stocks suspended in China, the spillover has hit the U.S. market hard.

“According to PricewaterhouseCoopers’ March 31, 2015 list of the largest 100 global companies by market cap, there are 11 Chinese companies in that group. We took a look at trading in just two of those names yesterday, China Mobile and China Life Insurance, both of which trade as ADRs on the New York Stock Exchange.

“We looked at how China Mobile and China Life Insurance traded before, during and after the New York Stock Exchange halted trading in all of its securities. An interesting pattern emerged…After volume spikes in the morning prior to the trading halt by the Exchange, volume was subdued during the hours the Exchange remained closed. (Other trading venues are supposed to pick up the slack when an exchange goes dark.)  Then volume picked up again when the Exchange reopened. China Mobile (symbol CHL) closed down 5.38 percent yesterday while China Life Insurance (symbol LTR) dropped 6.65 percent in New York trading.”

The worry on Wall Street is whether traders in New York will be willing to provide a two-sided market in Chinese shares at a time when the stock market situation there, as well as the economic situation, is deeply clouded.

Reuters reported that 2,247 Chinese stocks fell overnight while a meager 77 shares gained in price. The wire service also reported: “More than 1,500 shares listed in Shanghai and Shenzhen dived by their 10 percent daily limit.” When a stock market halts trading because a stock is limit-down 10 percent, that aborted selling pressure in China can seek relief in the next stock market to open where Chinese stocks are traded – like the New York Stock Exchange.

The wildly inflated price to earnings ratio of many Chinese stocks is drawing parallels in some investor minds to Japan’s Nikkei 225 index in 1989 when there were predictions that it would zoom to 45,000. On December 29, 1989, the Nikkei closed at 38,916. By 1991 it was below 25,000. By 1992 it was under 17,000. During the global crash in 2009 it traded in the 7000s before bottoming out. Today, the Nikkei finished at 20,350.10 – still down 48 percent after 25 years. After the 1929 crash, it took the U.S. market exactly 25 years to regain its peak.

As we’ve been writing this article, the Dow Jones futures have moved from a loss of -91 to a loss of -111 to a loss of -125. Trading in New York will be worth watching this week.

JPMorgan Chase Closes at All-Time High – As Financial Crises Sprout Like ‘08

By Pam Martens and Russ Martens: July 23, 2015 

JPMorgan Chase's Stock Chart, July 16, 2008 Through August 11, 2008

JPMorgan Chase’s Stock Chart, July 16, 2008 Through August 11, 2008

From the looks of JPMorgan’s share price, one would think the financial world is bathing in a sea of tranquility rather than experiencing crashing commodity prices, tremors in the Eurozone, Canada acknowledging two quarters of contraction, ruptures in China’s stock markets, and energy and mining junk bonds losing 20 to 30 percent in a month.

JPMorgan’s share price hit an all-time closing high of $70.08 yesterday. The scary thing is, JPMorgan’s stock had a run from $32 to $42 just one month before Lehman Brothers blew up in 2008, marking the beginning of the biggest financial crash since the Great Depression; and there had been a year of financial warnings prior to that. (So much for global bank share prices being a bellwether on global financial stability.) Once the 2008 crash was clearly underway, JPMorgan shareholders saw 70 percent of their share price evaporate in a six-month stretch ending in March 2009.

JPMorgan is not some folksy community bank in New England with no counterparty exposure to other global banks or debt-ridden corporations. JPMorgan Chase is a global bank with over $2 trillion in assets “serving corporations and individuals in over 100 countries,” according to its web site.

Graph from Office of Financial Research Report on Systemic Risks in U.S. Banking System (Symbols JPM and C denote JPMorgan and Citigroup, respectively.)

Graph from Office of Financial Research Report on Systemic Risks in U.S. Banking System (Symbols JPM and C denote JPMorgan and Citigroup, respectively.)

In February, the U.S. Treasury’s Office of Financial Research released a report showing staggering levels of interconnected risk among global banks. JPMorgan Chase had the highest overall score for systemic and interconnected risk.

The report was written by Meraj Allahrakha, Paul Glasserman, and H. Peyton Young and found that five U.S. banks had high contagion index values —JPMorgan, Citigroup, Morgan Stanley, Bank of America, and Goldman Sachs.

The authors write:

“…the default of a bank with a higher connectivity index would have a greater impact on the rest of the banking system because its shortfall would spill over onto other financial institutions, creating a cascade that could lead to further defaults. High leverage, measured as the ratio of total assets to Tier 1 capital, tends to be associated with high financial connectivity and many of the largest institutions are high on both dimensions…The larger the bank, the greater the potential spillover if it defaults; the higher its leverage, the more prone it is to default under stress; and the greater its connectivity index, the greater is the share of the default that cascades onto the banking system. The product of these three factors provides an overall measure of the contagion risk that the bank poses for the financial system.”

Just this past Monday, the Federal Reserve announced that JPMorgan Chase faces a $12.5 billion shortfall in meeting the Fed’s 4.5 capital surcharge imposed on it because of its sprawling size and interconnectedness. That doesn’t seem like news that should send the bank’s stock to an all time high.

Things are now getting so tense on Wall Street that two investing icons, Carl Icahn and Larry Fink, had a war of words on stage at an investment conference last week. Here’s how the Wall Street Journal’s David Benoit tells what happened:

“ ‘BlackRock is an extremely dangerous company,’ Mr. Icahn proclaimed at CNBC’s Delivering Alpha conference in New York…Mr. Icahn steered the bulk of the conversation away from activism—the billing of the event—to his growing fears about a bubble in high-yield bonds and what he called dangers of exchange-traded funds [ETFs] run by firms like Mr. Fink’s.

“Mr. Icahn blamed the increasing prices for such relatively risky debt partly on Mr. Fink’s sprawling, $4 trillion asset manager and its exchange-traded funds, which Mr. Icahn said were causing a liquidity problem because they have snapped up so many assets…”

The fear is that there will be no buyers if investors in junk bond ETFs panic and stampede for the exits. Icahn is not the only person worrying about this scenario. In June, Richard Berner, Director of the Office of Financial Research, appeared at the Brookings Institution to discuss recent bouts of bond market illiquidity. Berner quoted SEC Commissioner Michael Piwowar on the issue of ETFs, who has said:

“The growth of bond mutual funds and exchange-traded funds in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets than they did before the financial crisis…their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions.”

We may be closer to that trigger than many investors realize. Bloomberg Business is reporting this morning that “SandRidge Energy Inc. bonds have lost almost 30 percent since June, while notes of miner Cliffs Natural Resources Inc. are down more than 27 percent.” The article also notes that bonds of distressed debt issuers “are on pace to lose more than 20 percent for the second straight year, the worst performance since 2008.”