Political Calculations
Unexpectedly Intriguing!
June 26, 2017

For a market where the S&P 500 isn't changing very much, there's a remarkable about of tension building up in it. Or more accurately, there is tension building in the halls of the big investment banks where big bets are being made, such as JPMorgan, whose top quantitative analyst is seeing great cause for concern that hasn't translated into market volatility (via ZeroHedge):

After getting virtually every market inflection point in 2015, and early 2016, so far 2017 has not been Marko Kolanovic's year, whose increasingly more bearish forecasts have so far been foiled repeatedly by the market, and the same systematic traders that he periodically warns about. As a reminder, his most recent warning came last week, when he cautioned that even a modest rebound in VIX could lead to dramatic losses for vol sellers. As a reminder, here is the punchline from his latest note:

Days like May 17th and similar events "bring substantial risk for short volatility strategies. Given the low starting point of the VIX, these strategies are at risk of catastrophic losses. For some strategies, this would happen if the VIX increases from ~10 to only ~20 (not far from the historical average level for VIX). While historically such an increase never happened, we think that this time may be different and sudden increases of that magnitude are possible. One scenario would be of e.g. VIX increasing from ~10 to ~15, followed by a collapse in liquidity given the market’s knowledge that certain structures need to cover short positions.

So in light of a market that refuses to post even the smallest of drawdowns (we are not sure if the words "selling", "correction" or "crash" have been made illegal yet), has Kolanovic thrown in the towel and declared smooth seas ahead? To the contrary: in a note released late last night, he echoes warnings made recently by both Citi and BofA, and predicts that receding monetary accommodation from ECB and BOJ will likely lead to "market turmoil, and a rise in volatility and tail risks" and just in case there is some confusion, he reiterates what he said last week, namely that the "key risk of option selling programs is market crash risk."

What Kolanovic is describing is a realistic mechanism by which stock prices might suddenly change dramatically for the worse. But is there anything to it?

That's where we have an angle on the story. Going by our dividend futures-based model, we would see that kind of potential plunge in stock prices as a sudden shift in investor focus from 2017-Q4, where our model suggests that investors are largely holding their attention at this time, to instead focus on 2017-Q3, where if such an event happened, it would likely coincide with a 300-350 point decline in the value of the S&P 500.

Alternative Futures - S&P 500 - 2017Q2 - Standard Model - Snapshot on 23 June 2017

Now, here's the catch. For that to happen, something would have to fundamentally change in the expectations that investors have about the future to compel them to focus on 2017-Q3 instead of 2017-Q4.

One entity with the power to do just that is the Federal Reserve, which can in effect "command" investors to focus on 2017-Q3 through the statements its officials make about their plans for the timing of the Fed's next change in the Federal Funds Rate, which would affect all short term interest rates in the U.S. At present, our model suggests that investors only see a 16% probability of them taking that kind of action in or by its September 2017 Federal Open Market Committee meeting, but some Fed officials have been pushing in that direction, which explains why investors are not 100% focused on 2017-Q4 as the most likely timing for the Fed's next interest rate adjustment.

Another factor that can shift the attention of investors is the changing expectations for future earnings in the companies that make up the S&P 500. For example, should oil prices fall even further than they have in the last several weeks, that could reignite the concern that the oil and gas sector of the U.S. economy is in for a new round of economic distress, which could lead investors to focus on these companies in the near term, pulling the index down along the way.

Or, oil prices could rise sharply, which would both boost the oil and gas sector of the U.S. economy while straining other sectors, which would also have the same effect. Or, they could rise just enough, contributing to the kind of inflation that would potentially prompt the Fed to pull the trigger on its next rate hike sooner than investors are expecting today.

In all this, the random onset of new information is the potential trigger for unleashing a significant change in the S&P 500, where the interactive dynamics are both very complex and periodically chaotic.

And that's just considering how changes in how far forward in time investors are focusing their attention might affect stock prices. If the expectations for future dividends themselves change, that would very directly affect stock prices, which adds a whole other level of complexity in how stock prices behave.

Speaking of which, if you want to know which scenario might apply before Kolanovic's mechanism becomes engaged, you might want to keep up on the information coming into the market....

Monday, 19 June 2017
Tuesday, 20 June 2017
Wednesday, 21 June 2017
Thursday, 22 June 2017
Friday, 23 June 2017

Elsewhere, Barry Ritholtz summarized the positives and negatives for the economy for Week 3 of June 2017.

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June 23, 2017

Summer 2017 is turning out to be something of a disappointment at the cineplex. So, with that thought in mind, we're going to do what millions of teens this summer are doing and turning to YouTube for the kind of fun that used to come with Hollywood's biggest blockbusters, but which seems to be in too short of supply this summer. Enjoy!...

But wait, we have a double feature!

In other, important entertainment news, Hollywood director Joel Schumacher has finally apologized for Batman and Robin, which almost completely counteracted all that was good at the movies in the summer of 1997.

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June 22, 2017

We're almost to the end of 2017-Q2, so we'll take one last snapshot of how the pace of dividend cuts being reported in our ongoing real-time sampling are stacking up for the calendar quarter. First, here's how the second quarter of 2017 compares with the preceding quarter of 2017-Q1:

Cumulative Announced Dividend Cuts in U.S. by Day of Quarter in 2017, 2017-Q1 and 2017-Q2, Snapshot on 2017-06-21

As of 21 June 2017, the number of dividend cuts announced during 2017-Q2 is slightly higher than what was reported in 2017-Q1, with 44 in the current quarter's sample as compared to the previous quarter's 41 as of the same relative point of time in the quarter.

But 2017-Q2 is well behind the year ago quarter of 2016-Q2's total of 59 dividend cut announcements through the similar point of time in the quarter....

Cumulative Announced Dividend Cuts in U.S. by Day of Quarter, 2016-Q2 vs 2017-Q2, Snapshot on 2017-06-21

All in all, the number of dividend cuts in the quarter are consistent with recessionary conditions being present in the U.S. economy.

In our sampling, about 41% of the firms announcing decreases in their dividend payments to their shareholding owners are in the oil and gas sector of the U.S. economy, which follows from the reduced revenues they're earning with reduced oil prices in the global market.

There is also a high percentage of financial firms and real estate investment trusts in the mix, which combine to account for 25% the total. The remaining firms come from seven different industries, most notably chemical producers that produce agricultural fertilizers, where that industry accounts for 11% of the sampled 44 dividend cutting firms during in the quarter.

Data Sources

Seeking Alpha Market Currents. Filtered for Dividends. [Online Database]. Accessed 21 June 2017.

Wall Street Journal. Dividend Declarations. [Online Database]. Accessed 21 June 2017.

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June 21, 2017

The U.S. government passed a unique milestone in May 2017, where it has now cumulatively borrowed more than $1 trillion from the public since President Obama was sworn into office in January 2009, just so it can loan the money back out to Americans who need to borrow money to go to college in the form of Federal Direct Student Loans.

Money Borrowed by the U.S. Government to Finance the Federal Direct Student Loan Program, FY 1998 (October 1997) through FY 2017 (May 2017)

President Obama is directly responsible for this state of affairs. After being sworn into office on 20 January 2009, his first major domestic policy act was to sign the American Recovery and Reinvestment Act of 2009 into law on 17 February 2009 in an attempt to jump start a U.S. economy that had fallen into deep recession. Better known as the "Stimulus Bill", the act boosted the subsidy amount and quantity of Pell Grants paid to low and middle income-earning Americans attending college, but not by enough to cover more than one-third of the average annual cost of a university education, where American students who received these grants would then have to make up the difference through taking out student loans that are subsidized by the U.S. government.

Then, on 30 March 2010, President Obama signed the Health Care and Education Reconciliation Act of 2010, which resulted in the U.S. government taking over the student loan industry from the private sector.

President Barack Obama signed a law Tuesday that he said will end subsidies for banks that guarantee federal student loans, saving $68 billion over 11 years by making loans directly through the U.S. Department of Education. 

The overhaul of the student loan industry is part of the Health Care and Education Reconciliation Act of 2010, which was passed by Congress to reform the nation's health care system. 

According to the White House, starting July 1 all federal student loans will be direct loans administered through private companies that have performance-based contracts with the DOE. 

At present, the law appears set to fail on delivering these promised savings to U.S. taxpayers. For that portion of the story, please scroll down and click through!...

Previously on Political Calculations

U.S. Student Loan Implosion - We looked at the Federal Direct Student Loan program from the perspective of the student borrowers, where $137 billion worth of loans that have come due are either delinquent (more than 90 days without any payment being made) or are in default (more than 270 days without any payment being made).

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June 20, 2017

How likely is it that the U.S. economy will go into recession sometime in the next year?

The combination of rising short term interest rates and falling yields for long term bonds is often considered to be a harbinger of recession in the U.S. economy. And with the Fed having left its Zero Interest Rate Policy behind while the yields on long-term U.S. Treasuries have been falling in recent weeks, we thought it was time to dust off the version of the Recession Probability Track visualization tool that we introduced in September 2007 to indicate the odds that the U.S. economy would be in recession up to a year later.

Back then, the historical data we showed in our Recession Probability Track indicated that the odds of a recession beginning in the next year had already peaked back at 50% back on 4 April 2007, which is to say that it was signaling that there was at least even odds of the U.S. having a recession begin by 4 April 2008. As it turned out, the National Bureau of Economic Research determined that the U.S. economy expanded all the way through December 2007, before beginning to contract into recession in January 2008, where what we now call the "Great Recession" is considered to have begun in December 2007, coinciding with the peak of the preceding period of economic expansion, marking Month 0 of the recession that would last until the NBER determined that it bottomed in June 2009.

The last time we showed the Recession Probability Track was 6 November 2008. Just over a month later, the Fed would implement its Zero Interest Rate Policy, which would render the Recession Probability Track useless as a recession prediction tool for the next 7 years, until the Fed stopped holding its thumb on the zero end of the scale in December 2015.

Today, some four small interest rate hikes later, the Fed can still be considered to be applying pressure at that end of the scale, but not so much as to prevent the Recession Probability Track from registering a non-zero probability....

Recession Probability Track, 2 January 2014 through 19 June 2017

At 0.17%, we find that there's very little probability of what the NBER might someday declare to be a full-blown recession breaking out in the U.S. economy sometime between now and 19 June 2018. At least, not one propositioned on Jonathan Wright's yield curve-based recession forecasting model, which factors in the one-quarter average spread between the 10-year and 3-month constant maturity U.S. Treasuries and the corresponding one-quarter average level of the Federal Funds Rate. If you'd like to do that math for yourself, we have also built a very popular tool to help with that!

That doesn't mean however that the U.S. economy might escape without experiencing some level of distress. As we saw from mid-2014 through 2016 in oil and gas production states in particular, along with some other states whose major industries are linked to the health of that sector of the economy, it is possible for some degree of significant economic contraction to occur without leading to a national recession.

For other takes on the same data trends and what it might mean for the prospects of a U.S. recession, be sure to check out Kevin Erdmann's thoughts on the flattening yield curve and Joshua Brown's perception that flattening is not threatening, as well as Mike Shedlock's contrarian speculation from a month ago.

Finally, we should also note that China has seen its yield curve invert in recent months, where our recession forecasting tool has become increasingly popular among readers there, even though it wasn't specifically designed to consider China's economic situation and history, so we don't know how well it might work for assessing that nation's recession odds.

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