Mish's Global Economic Trend Analysis

How the Junk Bond Bubble Supports Rising Equity Prices
China Hikes Rates Another Quarter Point; How will this Affect China's Stock Market and Property Bubbles?
Florida Gov. to Overhaul Medicaid, End Defined Benefit Plans for New Public Workers, Require 5% Contributions from Existing Employees

How the Junk Bond Bubble Supports Rising Equity Prices

Posted: 08 Feb 2011 03:49 PM PST

Yesterday, I was asked about statements I have made on numerous occasions that the recovery of the junk bond market helps explain the rise in equity markets. Here is the specific question:

Mish,

Can you explain why you frequently say that the corporate bond market supports the equities market? I don't see why it would have the major effect you seem to claim it does.

Let's go over the reasons once again.

Companies that cannot get financing go out of business.

In March of 2009 many corporations poised to go under because they could not get financing had exceptionally low stock market valuations. Even GE was on that list. Those stocks rose many multiples after Bernanke managed to revive the junk bond market.

When companies issue long-term debt at lower and lower yields, their interest expense drops.

The entire atmosphere of chasing yields lower is a sign of increased speculation across the board. One should expect stock prices to at least be firm in such conditions.

Everything changed when Bernanke stabilized junk bonds. Interestingly, Bloomberg discussed this situation today in Top Stories.

Maturity Wall Crumbles as $482 Billion of Debt Refinanced

The wall of bonds and loans maturing through 2014 has crumbled by $482 billion, or 44 percent, since 2009, reducing the threat of defaults and allowing companies to bring riskier deals to market. The amount of debt due in the next four years dropped to $671 billion, from $1.2 trillion in 2009, according to JPMorgan Chase & Co.

Some $163 billion of bonds and loans come due in 2011 and 2012, or about 60 percent of the refinancing activity in 2010. Clear Channel Communications Inc. said it plans to sell $750 million of bonds to repay $500 million of short-term loans.

Stronger economic growth and the Federal Reserve´s decision to keep benchmark interest rates at almost zero, while pumping $600 billion into the financial system by purchasing Treasuries, have driven down yields and spurred demand for low-rated debt. That´s allowed companies to seek new borrowings with fewer provisions that protect investors.

"The wall of worry has been greatly reduced," said Sabur Moini, the high-yield money manager at Los Angeles-based Payden & Rygel, who oversees about $2 billion of speculative-grade debt. "You've had a big rally for the last two years and that's allowed companies and underwriters to be more aggressive."

How much better can things get, especially with treasury yields soaring?

I believe junk bonds are priced for perfection and equities priced well beyond perfection.

Please see Negative Annualized Stock Market Returns for the Next 10 Years or Longer? It's Far More Likely Than You Think for details.

As I have said many times, when this all matters is anyone's guess.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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China Hikes Rates Another Quarter Point; How will this Affect China's Stock Market and Property Bubbles?

Posted: 08 Feb 2011 11:49 AM PST

China hopes to dampen inflation with another quarter point hike. Can China's strategy of baby-step rate hikes work given credit is expanding at 35% a year with GDP rising less than a third of that?

Please consider China hikes interest rates again to damp inflation

China's central bank raised interest rates for the second time in just over a month in a bid to dampen high inflation and guide blistering economic growth to a sustainable level.

The People's Bank of China announced Tuesday on its website that the benchmark 1-year deposit rate would rise by a quarter percentage point to 3 percent and the 1-year lending rate would increase by the same amount to 6.06 percent. The increases are effective Wednesday.

In January, the central bank signaled that fighting inflation would receive priority this year, saying in a report issued after an annual planning meeting that "stabilizing price levels will receive more prominent status."

Last year's rapid growth was driven by a flood of investment in property and other areas. Analysts have urged Chinese authorities to do more to rein in the lavish lending by state-run banks that is driving investment, a large chunk of which is believed to be in speculative property deals.

In January, the banking regulator again ordered banks to tighten risk controls after the country's biggest state-run commercial banks splashed out nearly 240 billion yuan ($36.4 billion) in new loans in the first 10 days of the year.

Authorities are also considering ways to penalize banks for flouting orders to cut back lending.

Borrowing for real estate development and other projects is the lifeblood for the sales by local governments of land use rights that provide a huge share of their revenues. Such sales rose 70 percent in 2010, helping push property prices 6.4 percent higher compared with a year earlier.

China's Real Estate Bubble Continues to Expand

Hiking rates a quarter point a pop reminds me of Greenspan's policy of hiking rates at a measured pace. US speculation in residential real estate went on for another three years, followed by another 18 months of commercial real estate speculation.

In theory, China has other options given the nature of its command economy. Then again practice is a different matter given China's expectation to grow 9-10% a year.

Currently it is taking credit growth 3-4 times GDP growth to achieve China's growth target.

Something has to give. Can China grow 10% without huge investment-driven growth, without rampant credit expansion? What about speculation in the stock market?

Michael Pettis at China Financial Markets expects the Chinese stock market to be firm until President Hu Jintao and Premier Wen Jiabao retire next year.

I am not so sure. It is quite possible a series of hikes weighs on the market. Besides, stock market rallies per se will not help China achieve its GDP targets.

In a newsletter Pettis writes ...

I am moderately bullish, but not because of GDP growth. I am bullish about stocks mainly because it seems to me that hot money inflows, rapid credit expansion, and the impact of still-rising inflation on real interest rates (which are already negative) will mean that money continues flowing into asset markets.

In addition, the single most important player in the market, the government, is able and very likely to behave in ways that are not subject to economic or value analysis. One consequence of this is that local markets do a poor job of rewarding companies for decisions that add economic value over the medium or long term.

When Do Imbalances Matter?

At some point, China will be forced to address massive imbalances in its investment-driven growth model, make numerous market-driven changes in its banking system, and address the untenable nature of its growth targets in general.

Will the stock market and China's economy wait for a leadership change or will the market force some changes via CPI spikes before then?

I suspect the latter. Moreover, it's entirely possible the series of quarter point baby steps hikes weighs on the equity markets sooner than expected, especially if the frequency of those hikes increases faster than expected, even if credit growth continues unabated.

Regardless, long term growth targets of 10% that take credit expansion 35% a year is not a sustainable situation.

Nonetheless, when China's imbalances matters is a subject of speculation. That the imbalances will be addressed by China voluntarily, or the markets forcibly, is not. China bulls have not factored this setup into their models.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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Florida Gov. to Overhaul Medicaid, End Defined Benefit Plans for New Public Workers, Require 5% Contributions from Existing Employees

Posted: 08 Feb 2011 02:25 AM PST

Florida Governor Rick Scott is planning sweeping changes that has public unions howling but corporations thrilled.

Budget Plans

Cut property and corporate income taxes by $2 billion
Transfer Medicaid recipients to managed-care plans
Require existing public employees to contribute 5% of their salaries to the retirement system
Put new public employees in 401K plans

The Wall Street Journal has more details in Florida Governor Seeks Cuts in Budget

Gov. Rick Scott called Monday for overhauling Florida's Medicaid program, curbing its pension system and trimming government services as he detailed a budget proposal he had promised would be full of big cuts.

Mr. Scott proposed transferring Medicaid recipients to managed-care plans, a move he estimated would save about $2 billion a year on average.

The savings would come mainly from reduced administrative costs and cuts to reimbursement rates for providers, according to people familiar with the budget. Several Florida counties are already experimenting with such a system, and the governor would like to expand it statewide.

In one of his more controversial recommendations, the governor proposed pension-system changes that would require public employees to contribute 5% of their salaries to the retirement system and would direct new hires into 401(k)-style plans. He estimated the changes would save about $1.4 billion a year.

Battle shaping up over pension proposal

The Miami Herald has some additional details in Battle shaping up over pension proposal

Florida's pension system is currently funded by state and local governments contributing the equivalent of between 9 and 10 percent of an employee's income toward retirement. In the case of high-risk workers like police and firefighters, the percentage is higher.

Scott has talked of a 5 percent buy-in by employees -- basically splitting the difference with the state.

"It's only fair that if you're going to have a pension plan, you're going to do just like the private sector does,'' Scott said.

Right Moves

These are exactly the right moves. I commend the budget plan. Scott's plan will put money in the hands of taxpayers via lower property taxes and require public union workers to pay their share.

Hopefully Governor Scott can get all of his proposals passed and other states follow.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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