An Orderly Unwind Of Stock Market Leverage?

Authored Wolf Richter via WolfStreet.com,

That would be a first, but it might be happening. Everything in slow motion, even market declines?  

There is nothing like a good shot of leverage to fire up the stock market. How much leverage is out there is actually a mystery, given that there are various forms of stock-market leverage that are not tracked, including leverage at the institutional level and “securities backed loans” offered by brokers to their clients (here’s an example of how these SBLs can blow up).

But one type of stock-market leverage is measured: “margin debt” – the amount individual and institutional investors borrow from their brokers against their portfolios. Margin debt had surged by $22.9 billion in January to a new record of $665.7 billion, the last gasp of the phenomenal Trump rally that ended January 26. But in February, as the sell-off was rattling some nerves, margin debt dropped by $20.7 billion to $645.1 billion.

By March, those worries have settled down, and margin debt ticked up a bit to $645.2 billion, but remained $20.5 billion below January, according to FINRA, which regulates member brokerage firms and exchange markets, and which has taken over margin-debt reporting from the NYSE.

In January, days before the sell-off began, FINRA warned about the levels of margin debt. It was “concerned,” it said, “that many investors may underestimate the risks of trading on margin and misunderstand the operation of, and reason for, margin calls.” Investors might not understand that their broker can liquidates much or all of their portfolio “under unfavorable market conditions,” when prices are crashing. “These liquidations can create substantial losses for investors,” FINRA warned. And when the bounce comes, these investors, with their portfolios cleaned out, cannot participate in it.

This is why leverage such as margin debt is the great accelerator for stocks on the way up as it creates new liquidity that goes into buying stocks. And this is also why margin debt is the great accelerator on the way down, when forced selling kicks in and liquidity just disappears.

But this is not the scenario the markets are in at the moment. Everything is so orderly, though it’s a lot more volatile than it was during the run-up last year. And margin debt too has declined in an orderly manner:

For the 12-month period through March, margin debt rose $67.6 billion, down by nearly half from the 12-month period ended in January, when margin debt had soared $112.2 billion, the fifth-largest 12-month gain in the history of the data series, behind only the 12-month periods ending in:

  • December 2013 ($123 billion)
  • July 2007 ($160 billion)
  • March 2000 ($133.7 billion)
  • November 1997 ($132 billion).

Margin debt has soared since 2009, with only a few noticeable down-periods – including during the Oil Bust when the S&P 500 index dropped 19%, and the 2011 sell-off when the S&P 500 index dropped 18%. In March, it exceeded the prior peak of July 2007 ($416 billion) by 55%. But that’s down from 60% in January.

This chart shows the longer view:

During margin debt’s peak-to-peak surge of 60%, nominal GDP (not adjusted for inflation) rose 32% and the Consumer Price Index 20%. Historically, this disconnect has had a tendency to correct via messy panicked crashes and deleveraging. The last three spikes in margin debt are indicated in the chart above. The first two were followed by market crashes. And now?

Clearly, this will correct again. It always does. But the manner in which it corrects may well be very different, more orderly rather than panicky, taking its goodly time, given the glacial pace of the Fed’s tightening and the large amounts of liquidity still in the market looking for a place to go. And this type of gradual unwinding of stock-market leverage would be a first, but it might be happening before our very eyes.

The Fed’s new paradigm: everything in slow-motion. Read…  What’s Going On in the Treasury Market?

Israeli Defense Minister: “The Iranian Regime Is In Its Final Days”

Israel’s Defense Minister says Iran is on the brink of economic and military collapse, and that Israel will attack Tehran “and destroy every Iranian military outpost in Syria threatening Israel,” according to Arab-language publication Elaph and reported by Israeli media Thursday. 

They know that the Iranian regime is in its final days and will soon collapse,” said Israeli Defense Minister Avigdor Lieberman, adding “If they attack Tel Aviv, we will attack Tehran.”

Liberman suggested Iran is vulnerable on two fronts, economic and military – and that an American withdrawal from the Iran nuclear deal would significantly damage the regime’s economy during a period in which the Islamic Republic is devoting resources to a military build-up in Syria against the West. 

Iran is trying to establish bases in Syria and arm them with advanced weapons,” Lieberman said. “Every military outpost in Syria in which Iran seems to be trying to dig in militarily, we will destroy.”

Lieberman says that Israel must prevent an Iranian military build-up on their border. “We won’t allow it, whatever the cost,” he said.

Iran has repeatedly hit back against similar rhetoric, threatening to attack Israel directly. 

“If you provide an excuse for Iran, Tel Aviv and Haifa will be razed to the ground,” Ali Shirazi, an adviser to Iranian Supreme Leader Ayatollah Ali Khamenei, said in mid-April according to the Washington Times

Meanwhile, Axios reports that Israel has approached Russia several times over the last few weeks with demands that the Kremlin adhere to a cease fire arrangement signed with the U.S. last November, which includes preventing pro-Iranian militias from entering a buffer zone on the Syrian-Israeli border. 

The protests show Israel’s growing nervousness over the Iranian buildup in Syria. Recent flashpoints between Israel and Russia in Syria are also making it harder for the countries to maintain close coordination.

Israeli officials told me the message has been passed to the Russians by the Israeli ambassador to Moscow, by Israeli defense officials and at a senior political level. –Axios

Axios puts the cease fire deal in context: 

  • Last November, Russia the U.S. and Jordan signed a cease fire deal in southern Syria which established de-escalation zones on the Syrian-Israeli border and on the Syrian-Jordanian border. As part of the deal, a buffer zone was to be established which Pro-Iranian forces would be excluded from.
  • According to the deal, the Russians were the responsible for enforcing the zone. But Israeli officials told me that’s not happening at all. They claim pro-Iranian Shiite militias and Hezbollah elements are inside the buffer zone in violation of the deal.  

Will Russia rein-in Iranian rabble-rousers in Syria? Will the United States pull out of the Iran oil deal? Find out on the next episode of “not our problem.”

The Purge Begins: Deutsche Bank Fires 400 US Bankers

As part of its latest disastrous earnings, which saw trading revenues tumble by 17% as new CEO Christian Sewing took over, we reported that Deutsche Bank announced a sweeping restructuring plan, abandoning its long-running ambitions to be a top global securities firm, scaling back U.S. rates sales and trading, reducing the corporate finance business in the U.S. and Asia, and reviewing its global equities business with a view toward cutting it back, the bank said in a statement. The measures will lead to a “significant reduction” in the 97,130-person workforce this year, Deutsche Bank said. We translated it more simply: massive layoffs.

Predictably, the German bank wasted no time, and according to Reuters and Bloomberg, the purge began overnight when Deutsche fired 300 U.S.-based investment bankers on Wednesday with another 100 pink slips expected over the next 24 hours.

In total, the biggest German bank plans to cut more than 1,000 jobs, or over 10%, of total US jobs in its initial restructuring phase. According to Bloomberg, the US hosts about 10,300 Deutsche Bank employees, or about a tenth of the firm’s global workforce.

In his earnings call comments, CEO Sewing stopped short of disclosing how many of the bank’s 97,103 jobs would be let go…

… while CFO James von Moltke also gave few clues as to how much of its massive 1.4 trillion euro ($1.7 trillion) balance sheet would be shed in the process. Von Moltke estimated restructuring costs for 2018 would rise to 800 million euros, up from an earlier estimate of 500 million euros, according to Bloomberg.

“These cutbacks will be painful, but they are unfortunately unavoidable if we want to be sustainably profitable in the best interests of our bank, our clients and our investors,” Sewing said.

As noted earlier, the bank plans to reduce its activities across the board in the U.S. including rates sales and trading and corporate finance. Areas where the investment bank still believes it can grow globally include foreign exchange, commercial real estate and structured equity financing, Garth Ritchie, head of the investment bank, said in a memo to clients obtained by Bloomberg.

“Sandwich Crisis Deepens”: Subway Closes 500 Stores In 2018

The accelerating demise of Subway, the world’s largest restaurant chain, will one day be just another case study of how to run a once-spectacular business empire into the ground, as Americans quickly abandon this iconic sandwich chain in droves, seeking healthier and fresher, or just simply “different” food alternatives.

For the first time in its 52-years of operation, the company contracted in 2016, shuttering 359 US locations, which was the most significant retrenchment in its history. In 2017, the company closed another 800+ US locations, as details emerged that some one-third of shops in the US could be unprofitable.

Subway’s crisis could be linked to many factors: demographic shift, healthy eating trends, a disgraced ex-spokesman charged as a pedophile, and or managerial shifts. As we explained in December, it is only the tip of the iceberg for Subway’s closures, as we stated it is the “beginning of a crisis.”

And according to a new report from Bloomberg, the sandwich chain continues to close US stores at a record pace (which is not saying much as it has only had 2 full years of net closures in its entire history). Not even one month into the second quarter, management already announced that as many as 500 stores are closing across the country. While it is evident that Americans did not spend their Trump tax cuts on Subway sandwiches, the company is shrinking its North American footprint for greater opportunities in the U.K., China, India and Latin America, Bloomberg said. Last year, the chain closed +800 stores, bringing its total U.S. count to around 25,908 — well off the highs of 27,103 in 2015.

“We want to be sure that we have the best location,” Chief Executive Officer Suzanne Greco, 60, said in a phone interview. “We focused in the past on restaurant count. We’re focused now on strengthening market share.”

Store count isn’t everything,” she added. “It is about growing the business.”

Greco told Bloomberg that the company is struggling to increase sales in the U.S. as newer, more modern fast-food chains are crowding out the industry.

 

More from Greco:

“Subway had been hurt by fierce competition in the U.S., including from a resurgent McDonald’s Corp., whose domestic system sales rose 3.4 percent last year, according to data from researcher Technomic. Subway fell 4.4 percent. It’s also now faced with supermarkets and gas stations that are selling more grab-and-go fare, putting immense pressure on Subway to be faster and more convenient. Along with the closures, some locations are being relocated, and Subway is now using data from SiteZeus to choose better real estate.”

While the US segment clearly topped out in 2015, Greco told Bloomberg that her concentration today is on international expansion. She added the fast-food chain will add more than 1,000 locations outside North America and will primarily focus on the U.K., Germany, South Korea, India, China, and Mexico.

In summary, the compounding effect of store closures, eatery trends, waning restaurant industry, and poor advertisement choices, have ultimately dethroned the world’s largest restaurant chain, and now forced the company into a contraction phase for the third year in a row. And, as a last-ditch effort to preserve momentum and prevent further hemorrhaging of the sandwich empire, management has opted to shrink the North American segment for more, costlier opportunities abroad.

Merkel visits Trump without illusions, but with hope

BERLIN/WASHINGTON (Reuters) – Germany’s Angela Merkel visits U.S. President Donald Trump on Friday with no illusions of matching his “special relationship” with France’s Emmanuel Macron, but hoping to foster a broader dialogue on trade – one of a batch of tricky topics likely to be addressed.