05/22/18

China’s Debt-Trapping… U.S. Corporations Also Victims

By: Denise Simon | Founders Code

Congress knows it needs to amend the CFIUS law, yet no one has proposed any legislation. Complying with CFIUS is optional. All this while China is the largest applicant in the United States for patents and is buying up land in Washington State with nefarious intentions under the guise of farm land operations.

Meawhile:

Politico: The U.S. government was well aware of China’s aggressive strategy of leveraging private investors to buy up the latest American technology when, early last year, a company called Avatar Integrated Systems showed up at a bankruptcy court in Delaware hoping to buy the California chip-designer ATop Tech.

ATop’s product was potentially groundbreaking — an automated designer capable of making microchips that could power anything from smartphones to high-tech weapons systems. It’s the type of product that a U.S. government report had recently cited as “critical to defense systems and U.S. military strength.” And the source of the money behind the buyer, Avatar, was an eye-opener: Its board chairman and sole officer was a Chinese steel magnate whose Hong Kong-based company was a major shareholder.

Despite those factors, the transaction went through without an assessment by the U.S. government committee that is charged with reviewing acquisitions of sensitive technology by foreign interests.

In fact, a six-month POLITICO investigation found that the Committee on Foreign Investment in the United States, the main vehicle for protecting American technology from foreign governments, rarely polices the various new avenues Chinese nationals use to secure access to American technology, such as bankruptcy courts or the foreign venture capital firms that bankroll U.S. tech startups.

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05/22/18

The Third Worst 100 Day Sell Off In Corporate Debt In 18 Years

By: Kent Engelke | Capitol Securities

Bloomberg reports that: “Corporate bonds sink fast in one of the worst tumbles since 2000,” stating the current 100-day sell-off is the third worst in 18 years. The Newswire further states that last week was perhaps the capitulation, citing an increase in economic activity that questions monetary policy assumptions.

The issue I have at hand about the above statement last week was that it was regarded as a data-nonevent, defined as there was a dearth of top tier statistics released. Can I offer another reason? A regulatory induced change in bond market mechanics that is causing a proverbial liquidity trap.

As noted several times, the bond market has increased in size by over 200% since 2008, but money center bond inventories are down over 90%. This dearth of liquidity was exacerbated by yet another regulatory change implemented last week, a change that only those in the industry are discussing or can remotely understand.

Citigroup also warned yesterday all should prepare for a possible “normalization” of risk premiums across the credit spectrum as “the era of monetary distortion unravels.” Citicorp further commented as the economy’s “upward march in concert with a term premium—the extra compensation to hold longer-maturity Treasuries over short-term securities—would justify the 10-year at 4% to 4.5%.”

Wow! I must write that Citi does not necessarily see bond yields at such levels, but was merely stating this is where yields could go based upon historical precedence.

Speaking of precedence, a central theme of these remarks is the dissolution of the multipolar interdependent economy. Bond giant PIMCO wrote global economies are becoming less reliant on central banks and less coordinated, setting the stage for higher volatility. PIMCO’s view was perhaps encapsulated by its comment, “Markets will have to stand a lot more on their own. Economies will have to fend for themselves as the world becomes less interconnected.”

Economic nationalism is gaining momentum, not losing it as many pundits wrote six months ago. As noted many times, this nascent change of money gravitating to Main Street from Wall Street is gaining momentum where yesterday’s rules and benchmarks may no longer be valid.

Speaking of validation, equity markets advanced yesterday as a potential trade war between the US and China was put on hold according to Treasury Secretary Mnuchin.

Last night the foreign markets were mixed. London was up 0.14%, Paris was down 0.04% and Frankfurt was up 0.11%. China was up 0.02%, Japan was down 0.18% and Hang Sang was up 0.60%.

The Dow should open nominally higher on an easing of trade tensions. Italian politics — or the election of yet another economic nationalist government — has taken a back seat at this juncture. The 10-year is off 4/32 to yield 3.08%.

05/18/18

Has Regulatory Fiat Again Cause The Next Crisis?

By: Kent Engelke | Capitol Securities

It was a mixed day yesterday. Oil is at levels not experienced since November 2014. Technology came under pressure, the result of lackluster results from a former market leader. Economic data showed continued strength and the 10-year Treasury is now at yields last experienced in 2011.

And then there are the geopolitical issues from Korea, Middle East, China, to the surge of Italian populism that is demanding the abandonment of the mulitpolarity that espouses the EU.

Wow! Today is not the same as yesterday.

Speaking of change, in my view there is a huge change occurring in the $2.7 trillion corporate bond market, partially the result of a change in trading mechanics and partially the result of a change in monetary policy that is driving hedging costs considerably higher.

According to HSBC, a major change in global capital funds is underway that will create a “disorderly” retrenchment from dollar debts and “no developed credit market will escape the bearish correlations.” HSBC further states this dislocation may be amplified given the chronic lack of liquidity, the result of regulatory fiat that has greatly reduced the ability of money center banks to maintain orderly markets.

It is often written the newest regulations create the next crisis. I hope this axiom does not today materialize.

Last night the foreign markets were mixed. London was down 0.13%, Paris was up 0.13% and Frankfurt was down 0.02%. China was up 1.24%, Japan was up 0.40% and Hang Sang was up 0.34%.

The Dow should open flat ahead of conflicting geopolitical news. The 10-year is up 4/32 to yield 3.10%.

05/15/18

A Mixed/Quiet Day

By: Kent Engelke | Capitol Securities

Equities were mixed in thin trading. The 10-year stalled just below 3% as all assess the outlook for trade relations, tension in the Middle East and rising crude.

Some are perplexed why the averages are struggling given the increase in corporate earnings, near record levels of share repurchases and synchronized pick-up in global growth. I think the answer is relatively simple. It is about a change in monetary policy that questions valuations. Interest rates are the greatest factor of most valuation formulas.

As written a gazillion times, 50% of the volume is the result of algorithmic trading and 40% is done by ETFs/Indexing. If a major component becomes negative, prices will struggle.

I reiterate my long held thesis that monies are now gravitating back to Main Street from Wall Street, the inverse of the last 10 years. In my view, the massive exodus of funds to Wall Street is/was a major catalyst for the populist movement that has impacted all industrialized democracies.

The outcome of this transition is infinite. Economic nationalism and patriotism has been around since the formation of mankind. Multipolarity and interdependency was an idea birthed about 30 years ago and reached its apex under the Obama/Merkel/Sarkozy triumvirate.

Last night the foreign markets were mixed. London was up 0.26%, Paris was up 0.17% and Frankfurt was up 0.12%. China was up 0.91%, Japan was down 0.21% and Hang Sang was down 1.23%.

The Dow should open nominally lower as oil is up about 1% on Middle East tensions. The 10-year is off 5/32 to yield 3.03%.

05/7/18

China is Buying America with and without CFIUS

By: Denise Simon | Founders Code

Statistics found here.

When China is not buying America, they are busy in other parts of the globe buying places like Europe. That is how China is expanding, including stealing intelligence, espionage and hacking. The parts of Britain not owned by Russia are being gobbled up by China. Russia has a long plan and China has a long plan, not too sure about the United States, Britain or other allies.

There have been many discussions in Congress to reform CFIUS, Committee on Foreign Investment in the United States. The most widely noticed scandal with CFIUS was the Uranium One deal.

Anyway, John Carlin recently spoke with the National Law Journal about bipartisan legislation introduced in November in the U.S. Senate and House of Representatives by U.S. Sen. John Cornyn, R-Texas, and U.S. Rep. Robert Pittenger, R-North Carolina, respectively, to overhaul the CFIUS review process. CFIUS reviews, which are voluntary, are meant to protect the nation from business transactions that pose a national security or strategic risk to the United States. The panel has the authority to require the transaction’s parties to undertake risk mitigation, such as carving out a specific location or element of the deal.

The panel can also recommend that the president block a deal entirely. President Donald Trump, for example, in September blocked the sale of Oregon-based Lattice Semiconductor Corp. to a Chinese company. A deal by Anthony Scaramucci, briefly a White House communications director, to sell his stake in SkyBridge Capital to Chinese company HNA Group Co., which is partly government-owned, appears to be in jeopardy after not yet clearing its nearly yearlong CFIUS review, according to reports in financial media including Bloomberg News in mid-December.Treasury Secretary Steven Mnuchin, who chairs the panel, has urged toughening CFIUS reviews.

While leading the DOJ’s National Security Division, Carlin oversaw the indictment in 2014 of five Chinese military members for economic espionage for hacks against several big U.S. companies, among them United States Steel, Westinghouse, Alcoa Inc. and SolarWorld from 2006 through 2014. The division also investigated the cyberattack on Sony Pictures Entertainment in late 2014 that the U.S. government determined originated in North Korea; and brought charges with the FBI against seven Iranians working for computer companies under contract to the Iranian government and military that conducted cyberattacks between 2011 and 2013 against 46 financial institutions including Wells Fargo and JPMorgan Chase & Co. More here.

The CFIUS review process also appears to be affecting efforts by China Oceanwide Holdings Group Co. Ltd. to acquire Genworth Financial Inc.

BusinessInsider: In 2016, General Electric sold its appliances business to Qingdao-based Haier. China’s Zoomlion made an unsolicited bid for heavy-lifting-equipment maker Terex Corporation, and property and investment firm Dalian Wanda announced a deal to buy a majority stake in Hollywood’s Legendary Entertainment.

On Friday, a Chinese-led investor group announced it would buy the Chicago Stock Exchange. And then there’s ChemChina’s record-breaking deal for the Swiss seeds and pesticides group Syngenta, valued at $48 billion according to Dealogic.

There have already been 82 Chinese outbound mergers-and-acquisitions deals announced this year, amounting to $73 billion in value, according to Dealogic. That’s up from 55 deals worth $6.2 billion in the same period last year.

Last year was a record-breaker for Chinese outbound deals, with 607 deals valued at $112.5 billion in total. Just over one month into 2016, and China is more than halfway to breaking that record.

So what’s going on?

One interpretation is that Chinese companies are simply hungry for growth as that country’s economy slows, and they’re feeding themselves by buying other companies.

“With the slowdown of the economy, Chinese corporates are increasingly looking to inorganic avenues to supplement their growth,” Vikas Seth, head of emerging markets in the investment-banking and capital-markets department at Credit Suisse, told Business Insider.

Last year, investment bankers earned $558 million in revenue from Chinese outbound M&A deals, according to Dealogic. This year, that number is at $121 million to date.

But there are, of course, a number of challenge these deals will face — especially in the US.

M&A deals in the US are subject to scrutiny by the Committee on Foreign Investment in the United States, or CFIUS. It recently prevented the $3.3 billion sale of Philips’ lighting business to a group of buyers in Asia.

The 82 Chinese outbound deals announced so far in 2016 are worth more than half of 2015’s total Chinese outbound-deal value.

“I would be very surprised if CFIUS did not have an interest in taking a look at this deal,” said Anne Salladin of law firm Stroock & Stroock, referring to the Chicago Stock Exchange deal.

05/7/18

Is Economics 101 Wrong?

By: Kent Engelke | Capitol Securities

Economics 101 dictates low employment causes higher wages. Conversely, high unemployment dictates lower wages. Perhaps Economics 101 is wrong and today is the other bookend that commenced in the late 1970s.

To remind all, wages were surging in the late 1970s as cost of living adjustments (COLAs) became embedded in wages because of higher inflation. Most economists were stymied by rising wages as unemployment was close to double digits. Treasury yields were also close to double digits and real or inflation adjusted yields were around record levels.

Fast forward to today. The unemployment rate is at 3.9% and at the lowest level since 2000. Wage inflation is benign. Similar to the above, this is inverse of what most expect. Treasury yields are nominally higher than their historical lows and real yields are around record lows.

What gives? Yes, there are signs of wage pressures in the more inclusive employment cost index that is released on a quarterly basis, but most focus on the BLS monthly print. Perhaps it is the result of a labor participation rate (LPR) that is still hovering near historical lows. Yes, job creation remains well ahead of the natural growth rate of the labor force, but the pool of available workers, workers that are not included in the data are gargantuan, the result of government policies.

As this pool shrinks, I believe wages would then begin to rise.

The volatility at the end of last week was incredible. At one time Thursday, the Dow was down almost 400 points declining to its 200 day moving average only to rebound sharply by the close to end essentially unchanged. Friday, the Dow was off over 130 points, reversed and advanced over 400 points, to end higher by 325 points.

Wow! SkyNet is in control.

Commenting about oil, WTI closed Friday around $69.75/barrel, up almost 2%, the highest level since November 2014. Crude is now up about 50% in a year and 170% since its early February 2016 lows. For the first time in many years, a nominal geopolitical premium is now becoming embedded in prices.

The estimates vary greatly as to the impact to supplies if Iranian sanctions are again levied. Some are projecting a 2 million barrel decline, while others predict 500,000 barrels. Regardless, if sanctions are reinstated, oil supplies will further tighten.

Moreover, the vast majority of non-state and state oil producing firms are commenting about the possibility of a supply shortage given the lack of infrastructure spending in large upstream facilities.

Is the oil market about to face a perfect storm, a storm that is reminiscent of the one ten and twenty years ago? I place the odds at 75%. A major difference between today and yesterday are valuations. According to Goldman Sachs, oil equity is priced at the sharpest discount to crude in history and the lowest valuation in over 50 years in both a comparative and absolute manner.

What will happen this week?

This week the economic calendar is comprised of several inflation indices, sentiment indicators and inventory data. How will the data be interpreted?

Last night the foreign markets were up. London was closed over a holiday, Paris was up 0.07% and Frankfurt was up 0.46%. China was up 1.48%, Japan was down 0.03% and Hang Sang was up 0.23%.

The Dow should open nominally higher. West Texas crude is above $70 for the first time since November 2014, as possible re-imposition of some US sanctions on Iran are now imminent. The 10-year is off 2/32 to yield 2.97%.

05/4/18

Adding Another 25 Cents to the Price of Gas at the Pump

By: Denise Simon | Founders Code

Sigh….would that revenue be applied to pay off U.S. debt? Nah…

Commerce Secretary Wilbur Ross, who called raising gas taxes a ‘horrible idea,’ says Trump is considering a hike

  • Raising the federal gas tax is one of several options President Donald Trump is considering to pay for infrastructure spending, Commerce Secretary Wilbur Ross said.
  • The president proposed an increase of 25 cents per gallon last week, according to several sources.
  • Ross, who once called raising the federal fuel levy a “horrible idea,” on Thursday said it’s logical to charge drivers for road improvements.

Enter the U.S Chamber of Commerce:

The U.S. Chamber has long believed that implementing a modest increase in the motor vehicle fuel user fee (also known as the gas tax) is the simplest, fairest, and most effective way to raise the money that America needs to fund critical upgrades to our roads, bridges, and transit systems.

Earlier this year, and for the first time, we threw out a number: 25 cents. By raising the federal gas tax by 25 cents—five cents per year over five years—we could raise $394 billion over the next decade, and it would only cost the average motorist about $9 a month.

That’s the kind of money we need to be investing in our nation’s infrastructure system. It’s that important, and we won’t be able to build what we need to build if we do it on the cheap.

So far, we’ve seen strong support for our proposal from across the U.S. business community, and a few weeks ago, President Trump indicated his openness to backing a 25-cent increase as part of his administration’s infrastructure modernization efforts.

Despite the momentum that exists to come up with a long-term and sustainable funding solution for America’s infrastructure woes, our concrete and common-sense proposal has met resistance from some corners of Washington, most of it based on incomplete information about the gas tax and the impact of an increase.

To help fill that gap, we’ve compiled five assertions we’ve heard about the gas tax over the last few weeks, and we’ve filled in parts of the story that have so far been missing from the debate.

1. Assertion: An increase in the gas tax is regressive.

Reality: Any user fee, toll, fare, or sales tax is by definition regressive. The fixed fee or tax is larger as a share of income the less the payer makes. A bus fare, for example, costs a larger share of income for someone who makes $30,000 a year than it does for someone who makes $300,000 a year.

The only way to avoid a regressive system of financing our highways and transit systems is to abandon the user fee model altogether and instead fund infrastructure out of general income taxes. Do opponents of adjusting the gas tax really believe a better alternative is raising income taxes and making the current code more progressive?

It is worth remembering that the costs associated with crumbling and substandard infrastructure are also regressive; inaction is expensive.

Forty-four percent of America’s major roads are in poor or mediocre condition. Driving on those bad roads costs U.S. motorists $120 billion a year in extra vehicle repairs and operating costs—$553 per motorist, in fact. Those bills are a bigger burden for low-income drivers than high-income drivers.

Congestion is also stealing time from American families. The average commute time to work has increased by 35 minutes a week between 1990 and 2015. Higher congestion means longer commutes and higher costs.

2. Assertion:  An increase in the gas tax would wipe out the benefits of tax reform.

Reality: The Ways and Means Committee has estimated that the typical family of four earning the median family income of $73,000 will receive a tax cut of $2,059. Based on average household consumption of gasoline, if a 25-cent increase in the motor fuel tax was implemented all at once (and it is more likely to be phased in) the additional fee would only be $285, a very small portion of the average family’s total tax relief.

Let’s not forget that thanks to common-sense energy policies and increased fuel efficiency, families today are paying less for gasoline. In 2008, the average household expenditure for gasoline was $2,715.  In 2017, it is estimated to have been $1,197, a difference of $738. That savings is more than two times greater than the cost of increasing the motor fuel user fee.

3. Assertion: We don’t need to raise the gas tax. Congress should instead cut spending on bike paths and other wasteful items.

Reality: There is no question that Congress should repurpose any wasteful or low-priority infrastructure spending, but funding for so-called “transportation alternatives” is less than 2% of overall federal highway spending. And of that less than 2%, states are already authorized to transfer half of the funds from alternative projects to more traditional projects.

If you eliminated all funding for transportation alternatives, you would reduce the current $138 billion shortfall in the highway and transit trust fund by only approximately 6%. Furthermore, during the last two federal highway authorization laws (MAP-21 and FAST Act), Congress has substantially reduced the number of federally required programs from 112 to 12, therefore focusing limited dollars on programs with the greatest economic return.

Occasionally, critics will claim that “wasteful,” non-highway funding is much higher—say 20% or more of total spending. However, these critics only get to this larger number by lumping in funding for transit programs. The most recent highway bill provided approximately $10 billion a year in funding for transit programs. Since 1983, when President Reagan signed legislation dedicating a portion of the motor vehicle fuel user fee to transit programs, there has been no serious consideration of divorcing transit funding from highway funding. If Congress, were to do so, it would likely only mean that general fund spending would need to be increased to cover transit program spending, meaning no additional money for highways.

4. Assertion: States have already raised their own gas taxes, so there is no need for Congress to do so.

Reality: Support for our highway infrastructure has historically been a partnership between the federal government and state governments, with state government devoting more dollars to building and maintaining our highway system than the federal government. Adjusted for inflation, spending at all levels of government has been on the decline since 2000. State governments are raising their user fees in many cases in order to just maintain their level of support for highway modernization.  If the federal government fails to do likewise, the historic partnership will break down along with our infrastructure.

5. Assertion: Raising the gas tax is politically impossible.

Reality: Thirty-nine states have raised gas taxes since 1993, and some have done it several times.

We haven’t found a single lawmaker who has lost his or her seat solely because of a vote in favor of raising the gas tax. It may be a tougher vote in some regions of the country or for some elected leaders than others, but it’s a vote worth taking. Each and every day, American voters interact with our nation’s roads, bridges, airports, and more, and we believe voters will reward leaders who acknowledge that infrastructure investments can mean more economic growth and more prosperity.

05/2/18

Fed Meeting Concludes Today

By: Kent Engelke | Capitol Securities

Equities were mixed. Industrial and material shares fell while technology advanced. The catalyst for the decline was a lower than anticipated reading for a US manufacturing gauge. The ISM Manufacturing Index fell to a nine-month low, perhaps the result of delays in delivering product. A measure of order backlogs was the highest in almost 14 years and delivery times lengthened to match the second longest since March 2010. The prices paid component rose to the highest since April 2011.

In my view, the above is a text book example of “demand pull inflation” defined as potential bottlenecks that are creating delivery delays and higher prices.

This data generally supports the theme that rising input costs may impact margins which may challenge valuations unless costs are passed onto the end user or greater efficiencies are found. Unfortunately, profit margins are at or near record levels and any increase in input costs may have an outsized effect.

Friday, the all-inclusive employment data is released. Will this data suggest wage inflation is accelerating? If so, how will it be interpreted? Some will make a bullish argument, while others bearish.

What will happen today? Will the outcome of today’s Fed meeting impact trading?

Last night the foreign markets were mixed. London was up 0.36%, Paris was up 0.14% and Frankfurt was up 1.15%. China was down 0.07%, Japan was down 0.16% and Hang Sang was down 0.27%.

The Dow should open flat. The 10-year is off 6/32 to yield 2.99%.

04/25/18

An Ugly Day

By: Kent Engelke | Capitol Securities

Many are stating there is no place to hide. At casual glance, it appears all sectors are crumbling. Yesterday, the must owned technology stocks were again routed at the same time the industrials took a pounding. Last week, the consumer non-durables had great difficulty.

The catalysts are many, but I would focus on two. The first is rising interest rates. The 10-year Treasury is now at the highest level in four years, the result of greater economic activity and perhaps the commencement of QT. The second potential catalyst is earnings. Results have generally met lofty expectations, but as noted last week more is required.

Technology based trading dominates the markets, trading based upon momentum, earnings and interest rates. In many regards, liquidity is virtually absent as speed and cost of execution are viewed as more paramount than market stability mechanisms; mechanisms that are absent because of regulatory fiat.

I reiterate, long held thesis money is now gravitating back to Main Street from Wall Street. In my view, this nascent trend will become more pronounced.

In my view, passive investing has reached its apex. I still cannot comprehend that there are more indices than listed securities. Wow!

What will happen today?

Last night the foreign markets were down. London was down 0.81%, Paris was down 0.86% and Frankfurt was down 1.69%. China was down 0.35%, Japan was down 0.28% and Hang Sang was down 1.01%.

The Dow should open moderately lower as the 10-year is clearly over the psychological barrier of 3.0%. The dollar is also strengthening to a three-month high which may suggest American goods may not be as competitive abroad. The 10-year is off 6/32 to yield 3.03%.

04/20/18

3% 10-Year Treasury Again In View

By: Kent Engelke | Capitol Securities

A 3.0% 10-year Treasury is again in view. To remind all, about two months ago the prospect of this benchmark was almost a certainty after a relentless climb from 2.4% at the start of the year. But a retreat ensued sending the 10-year as low as 2.72% in early April. Today, the yield is 2.92%, the highest in about eight weeks.

The accepted reason for the increase is greater than expected growth and inflationary pressures. I would like to add another… the massive impact of electronic based trading. The SEC states 99% of Treasury trading is done electronically utilizing algorithmic models.

I believe the next market crisis will not be an economic crisis, but rather a liquidity crisis. Liquidity is virtually absent given the changes in capital requirements and the inability of money center banks to take risk… aka hold inventories.

The regulatory entities are more concerned about speed of execution and risked based capitalization. Treasury trading has morphed electronically, which emphasizes speed, but not capitalization. What happens if there is a systemic event that causes a dramatic change in economic or monetary assumptions?

Liquidity is absent and prices could fall dramatically.

I vividly recall three periods of a radical change in sentiment… 1987, 1994 and 2008. In both 1987 and 1994, yields rose dramatically and 2008 yields fell dramatically.

What are the odds 2018 will be the inverse of 2008, but only on steroids given the lack of liquidity?

As noted many times, oil is at the highest level since December 2014, an environment few thought would unfold. Steel, aluminum, copper and lumber prices are surging, another unexpected event. Will demand pull inflation morph into cost push inflation?

Like many, I believe the secular bond bull market is over. However, I believe few have experienced a selloff in prices given that last one took place over 24 years ago. I read a statistic that average tenure of a bond trader is about 7 years and the number of bond professionals have dropped by over 60% because of technology; technology that I will argue does or cannot factor a systemic event.

As written before, it is all about speed of execution and market stabilizing forces are no longer available because of the long arm of government.

What will happen today?

Last night the foreign markets were mixed. London was up 0.44%, Paris was up 0.41% and Frankfurt was down 0.19%. China was down 1.94%, Japan was down 0.13% and Hang Sang was down 0.94%.

The Dow should open flat. The 10-year is unchanged at 2.92%.