Greg Weldon
Jul 18, 2007 9:43 am
Scalpel in hand I dig right in, carving up the Chinese data on money supply, bank lending, and official reserves, reflecting the continuation of a secular trend dominated by the still ‘rising tide’ in excess global dollar supply.
- The official FX Reserves are $1.333 trillion.
Whew, seems like an astronomical figure… until you consider the single-month export total exceeding $100 bln for the first time ever in June.
What is interesting is the quarterly "flow-of-funds":
- The official FX Reserves are up +$130.6 bln during 2Q, similarly oversized and in line with the record rise posted in 1Q, at plus +$135.7 bln.
In other words, $266.3 bln in reserve accumulation during the first six months of the year, or more than all of last year, with 12-month full-year-2006 reserve growth of + $247.3 billion
Note the sequential quarterly reserve growth back to the end of ’05:
- 4Q-05: Up +$49.9 bln
- 1Q-06: Up +$56.2 bln
- 2Q-06: Up +$66.0 bln
- 3Q-06: Up +$46.8 bln
- 4Q-06: Up +$78.4 bln
- 1Q-07: Up +$135.7 bln
- 2Q-07: Up +$130.6 bln
This is a moonshot on the back of skyrocketing monthly export figures.
China is now accumulating dollars at a half-trillion per year pace.
Let’s take a look at the Export breakdown, by YTD year-year growth rate, first focusing on rising commodity exports:
- Corn: Up +112.7%
- Refined Oil Products: Up +30.5%
- Raw Silk: Up + 73.3%
- Precious Metals/Jewelry: Up +21.3%
- Cut Timber: Up +21.3%
- Steel Products: Up +136.4%
And in consumer goods, of course:
- Handbags: up + 22.7%
- Garments: up + 21.7%
- Footwear: up + 17.2%
- Motorcycles: up + 16.0%
- Toys: up + 24.4%
- Furniture: up + 22.5%
- Electronics: up + 27.1%
Indeed, commodity export growth rates are now well ahead of the expansion in consumer goods, though growth in consumer goods exports remains very respectably robust.
But within the context of this possible "skew" in export data, I cannot help but note the irony of the fact that Shipping Containers held a high spot on the list, in terms of most rapid export growth:
- Shipping Containers: Up +79.6%.
Hmm... exporting shipping containers? For what? More raw commodities.
Indeed, note the Chinese import growth ‘list’ (YTD year-year growth):
- Iron Ore: up +40.2%
- Refined Copper: up +95.8%
- Scrap Copper: up +94.2%
- Scrap Aluminum: up +38.5%
- Edible Oils: up +93.6%
- Fertilizer: up +32.5%
- Polyester Sheets: up +89.9%
- Paper Pulp: up +25.4%
- Logs: up +45.5%
Bingo. Chinese imports quietly had their third highest single-month total ever, pegged in June at $76.4 bln, up from an equally large $71.6 bln, and in line with April’s all-time high of $80.6 bln.
Yes, imports were almost a quarter trillion during 2Q. The CRB Index of commodity prices hit a new record high today.
Back to the Chinese data, as I dig into the bank lending/money numbers:
- M-1 Money Supply: expanding at a +20.9% yr-yr pace, accelerating from May’s +19.3% growth, and posting the fourth month out of the first six months of the year to boast growth above +20% yr-yr.
- M-2 Money Supply: grew at a +17.1% yr-yr rate in June, up from +16.7% growth seen in May.
- New Yuan Loans: expanded by +451.2 bln CNY, almost double May’s monthly expansion of +247.3 billion. June’s total marked the fourth largest single-month rise ever, and pushed the total above 25 trln for the first time ever.
My point is that this is not a juggernaut that will turn quickly, on any "front".
Rather, the push in commodity and energy prices, not to mention food might be enough to keep the Fed on hold, at a time when the Fed might not want to be on hold, given the disinflation creeping into the US consumer-mortgage-brokerage-housing-financial sectors. The risk to reflated ‘paper-wealth’ comes at a time when growth has slowed to a pace that only a sloth could love in disposable income (which is falling), and savings rate (which is negative) and jobs (less than population growth or growth in discouraged workers no longer looking for work).
In other words, we will not see the disinflation first, in China.
Rather, China might be the last place we would see it, right now.
I have always stated that disinflation would be seen first, and would creep up first within the US housing-consumer sectors.
I said we will see it first in the US credit dynamic. Already, from homebuilders to subprime lenders and broker dealers, it's now even threatening to tentacle into blue-chip banking types.
The curve is steepening. The dollar is cracking.
Commodities are rising, led by energy products and foodstuffs.
And yet, a disinflation in credit conditions appears to be developing, domestically in the US, finally, after seven solid years of concerted and coordinated reflation in all asset classes, fueled by excessively easy credit conditions and USD oversupply.
Now, swaps are widening.
Emerging bond credit spreads have widened.
Credit Default Swaps are "rising".
With that in mind, I recall the credit market debt held by US commercial banks, the growth in which has virtually collapsed.
Let's look at the US bank lending figures released at the end of last week, with a specific eye on last Friday’s data. Indeed, last Friday’s data lurks in the shadows as all-important, given the slide seen over the last two weeks.
Note the details:
- US Bank Credit: $8.567 trln, down (-)$19.9 bln, and marking the second straight week of decline, a rare occurrence.
- Loans and Leases: $6.273 trln, down(-) $7.5 bln
- Commercial and Industrial Loans: $1.258 trln, down(-) $8.3 bln from the previous week, a single-week decline of (-)0.7%, or a (-)34% annualized rate of contraction
- Real Estate Loans: $3.419 trln, down (-)$0.8 bln
- Consumer Loans: $760.5 bln, down (-)$4.2 bln
- Outside of a small one-week upside blip in Revolving Home Equity Loans, it was an across-the-board contraction in US commercial bank credit.
And, I also spotlight “Securities Loans”, pegged at $293.2 bln, far below the end-May total outstanding of $326.7 bln, setting up June to reflect a steep contraction in this bank lending measure, one that might also imply less upside support for US equities.
And speaking of ‘securities’ and the broader US stock market, I shine my technical spotlight on, of course, the US commercial banking behemoths, which have been upside leaders during the most recent bull market ‘leg’. First, I shine it on the Philly Bank Sector Index, or BKX, shown in the longer-term weekly chart exhibited below. Observe the "toppy" pattern, break of the previous low, push towards the long-term MA and severe bearish divergence within momentum, as defined by the (declining) long-term ROC. 
Very telling, in my opinion, as it relates to the real rate of paper wealth reflation, is the perspective offered in the chart below. In this weekly plot I compare the Philly Bank Index to the price of Gold, thus "adjusting" the index to reveal a totally different picture, a bearish picture in real terms, relative to the price of an ounce of Gold. Compared to bullion, banks are deflating at a rapid (-)30% two-year rate, and have been trending lower on a "real" basis since the secular peak in 2001. 
Without making any judgement as to the industry-specific fundamentals that are involved in pricing bank stocks, and without any specific targeting of one bank versus another, fundamentally or in terms of the management, I note some individual names, starting with Wachovia (WB).
Observing the mega-macro-monthly chart of Wachovia, seen below, I see a downside crack, and risk to the secular 5-Year Moving Average, in line with a severe breakdown in the On-Balance-Volume indicator, which suggests that long-liquidation is taking place and distribution may have already started. 
Of specific interest is the message delivered by the long-term monthly overlay chart shown below, in which we compare the cash S&P 500 Index (red line) to the price of Wachovia (blue bars). Wachovia led the broader market to the downside in the late 80s, and then to the upside throughout the 90s. Indeed, WB certainly led again, to the downside, during the 2001-03 debacle, and then one more time to the upside in 2005.
So, might Wachovia be implying renewed downside leadership?
Another very interesting technical dynamic is observed in Wells Fargo (WFC), shown in the weekly chart on display below revealing a flat-top and downside threat to the uptrend defining 2-Year Moving Average. I also note "sloppy" action in the On-Balance-Volume, and pinpoint the previous 2007 low as a key downside pivot, pegged at $33.
Most intriguing is the thought process generated by the chart on display below, a mega-macro-monthly Ratio Spread plot comparing Wells Fargo to the cash S+P 500 Index, dating all the way back to the mid-70s.
Clearly, Wells Fargo has been at the forefront of the secular trend towards paper wealth reflation via credit and excess USD liquidity. The last time that the secular 5-Year Moving Average was violated and turned down directionally was during the time frame that included the 1997-98 global-FX-depreciation and emerging market debt deflation, and the tech-deflation. 
One of our perennial upside favorites is cracking, as noted in the weekly chart of Bank of America, which reveals a violation of the seven year uptrend line, and a directional downturn in the long-term 2-Year Moving Average. The technical crack occurs in line with bearish divergence in the 52-Week ROC, which is now pushing perilously close to negative territory.
Aggressive speculators might contemplate the ‘short-side’ of the Vanguard Financial Sector ETF, the VFH VIPER, on display in the daily close-only chart seen below. The 200-Day EXP-MA has been violated following a failure to achieve a newer, higher high despite heavy money inflow as defined by the spike in On-Balance-Volume. A violation of the earlier 2007 swing low just below $62 would constitute a full-blown technical breakdown.
I would be most interested in this scenario if it were to "play out" in the context of a third straight week of Commercial Bank Credit contraction.
And I note a couple of "peripheral" names within the banking sector, such as UnionBankCal Corporation, seen in the weekly chart on display below. Observe the head-and-shoulders topping pattern and the push towards a possible "neck-line" violation. We also spotlight the downside violation of the multi-year uptrend line and subsequent successful "retest" of that line earlier this year.
Further, note the long-term 2-Year EXP-MA, which has turned down and contained this year’s rally attempts. And also, notice the fact that the 2-Year ROC (return) has plunged into negative territory, and will worsen with every "tick" that might occur below the late-2006 low. 
Perhaps we can suggest that First Commonwealth Financial is "leading" the way lower, as implied by the technical pattern evidenced in the weekly chart below. Indeed, we note a deepening negative reading in the long-term 2-Year ROC, with an accelerating slide in the long-term 2-Year Moving Average following a breakdown below the 2004-06 lows.
With Friday’s US Commercial Bank data imposing an omnipotent presence over the global markets, particularly the US equity market and credit-debt-spread markets, I also note a wild-card hidden within the macro-deck, waiting to be played, perhaps on the river, as a suck-out card that inflicts a bad-beat on asset reflation.
We note the Japanese Yen, and the potential for a yen appreciation, one that would exacerbate any continued contraction in US bank credit, perhaps enough so to impact global liquidity conditions. Observe the chart below plotting the USD versus the JPY, and focus on the Tuesday-Wednesday crack, which took the dollar back below the Jan-Feb-07 and May-June-07 highs, which had represented a JPY breakdown pivot.
The USD has held, so far, above the med-term 100-Day Moving Average, while the One-Month ROC has declined to near zero, leaving yesterday’s low of 121.00 as a key technical level, below which would constitute a dollar breakdown, and thus a yen breakout. 
Indeed, within the chart below I spotlight the last two occasions during which the JPY was above (USD below) the med-term MA, and the ROC was negative. For sure, the most recent occurrence defined a period dominated by intensified fear of a Yen-carry-liquidation driven tightening in global credit and liquidity conditions.
Still, it will take an event outside of Japan to provide the catalyst. The Yen-carry trade will not disinflate from within Japan, at least not until Japan's investors begin to reign in their own external investments, which remain huge and continue to flow, or exports slow. Evidence this week’s data on the Japanese Current Account Balance:
- Financial Account: "outflow" deficit of (-) 2.66 trln Yen in May, an increase of +50.2% y/y versus the deficit of (-) 1.77 trillion seen in May-06
- Income Balance … ‘inflow’ surplus of + 1.78 trillion yen in May, a year-year rise of +36.9% from the May-06 surplus of 1.30 trillion
- Export Revenue … ‘inflow’ surplus of 6.24 trillion yen, a sizable 12-month gain of 796 billion yen, for a year-year growth rate of +14.6%
Altogether, Japan’s Current Account Surplus expanded by much more than expected, rising at a +31.1% y/y rate, pegged at 2.14 trin yen, up from 1.98 trillion in April, and 1.62 trln in May '06.
With that in mind, we observe the daily overlay chart on display below, plotting the price of spot Gold (red bars) against the price of Gold ‘denominated’ in Japanese Yen, or Yen-Gold (blue line).
The recent divergence reflects the yen’s depreciation against most all other paper currencies, in a broad manner wide of the USD appreciation.
The last time the "divergence" was this wide, the Yen subsequently soared. 
Again, a break in USD-JPY below 121.00 would be a significant event.
This would be particularly true if it took place within the context of the above noted "scenario" which incorporates a breakdown in bank shares against a third week of decline in commercial bank credit.
Considering the lame job growth, deflating disposable income, worsening negative savings rate and eroding consumer confidence, I might suggest that a storm is brewing along the US horizon, despite the sunny and hot skies overhanging the foreign markets.
And if the Fed is held hostage by rising commodities led by energy and food prices and a depreciating dollar for too long, credit might begin to contract to the point where it will not be so easy for the Fed to reverse.
Subsequently, from the strategic standpoint I:
- Remain bullish on the energy sector (as per my ETF Playbook)
- Remain bullish on Asian and European stock indexes, relative to the US
- Remain bullish on mining shares, relative to the broad US stock market
- Increasingly interested in the bearish side of the banking-brokerage-financial sector in the US
- Continue to expect Yield Curve steepening
- Expect credit risk spreads to widen further
- Continue to look for Volatility expansion.
Round and round she goes, where the wheel stops… nobody knows.
Okay, I know. The wheel stops in the US.
Until then the wheel is barely slowing externally, as evidenced in Asian and European data on money supply, credit, and reserves.
As for when the wheel stops in the US, I am spotlighting data from the Fed on its own Balance Sheet, and that of the US Commercial Banks.
Simply, a third straight week of decline in US commercial bank credit, and any further weakness in the share prices of US banking behemoths, could cause the wheel to stop.
Stay tuned, all bets remain on the table.
