OVERNIGHT

Reuters rseported falling energy prices added to investor worries as Asian equities and the Chinese yuan recorded 4.5 year lows in trading Monday as the day of reckoning for the Fed's first interest rate hike in nearly seven years nears.

Trouble in the oil patch continues to contribute to the beggar thy neighbor global central bankers are playing. The People"s Bank of China continued Monday to guide the yuan lower, "setting," as Reuters reported, "a yuan/dollar official midpoint at the weakest since July 2011."

In a related story the WSJhttp://www.wsj.com/articles/dont-be-afraid-of-chinas-currency-gift-basket,investors were told the recent Chinese move to join a basket of currencies this time around appeared to be for real.

Every five years, China promises the world a currency basket, only to remain tethered to the U.S. dollar. Investors should be on guard that this time the basket is for real. Late Friday, in typical Chinese policy maker style, a currency department of the People’s Bank of China released a cryptic, unsigned editorial saying it would begin to publish a reference rate for the yuan against a trade-weighted basket of 13 currencies. The implication is that this new reference rate will be more important than focusing exclusively on the yuan’s rate versus the dollar. The PBOC said the new rate would be of “great significance.”

Just because it is publishing a rate, of course, doesn’t mean it has to follow it. In 2005, when China began to allow a gradual appreciation against the dollar, it said it would follow a basket. It repeated that promise in 2010, when it began to allow appreciation again after pausing during the global financial crisis.

But back then, a basket wasn’t in China’s short-term interests. The dollar was weakening, so even as the yuan appreciated against the U.S. currency, it weakened against its biggest trading partner’s currency at the time, the euro, and against the yen.

 Now is different. Staying tied to an ascending dollar means China has allowed its currency to become very strong against basically the entire world—except for the U.S. And it is at a time when Beijing has struggled to get the economy to respond to stimulus moves.

Following a basket will lead to further depreciation against the dollar. If done slowly and gradually, markets may absorb the change in stride, notwithstanding howls from the U.S. Congress. Yet the chance for dislocation remains high given that companies don’t invest based on a currency basket. Dollar exposure through offshore borrowing is a fact of life for Chinese real-estate companies, airlines and energy firms.

No doubt the timing—just before the U.S. Federal Reserve is this coming week expected to lift interest rates from near-zero levels—is aimed at getting ahead of further dollar strength. But it is not just a calculated, race-to-the-bottom depreciation. Following a basket is arguably a more rational way for China to let its currency adjust to economic circumstances.

TECHOLOGY IS AS IT DOES

Here are two stories one should be aware of. Recently, we mentioned that robots, not climate change, could turn out to be the biggest nemesis of humans. Since nearly everyone has a mobile phone these days, maybe the second story is also a prelude  to the destruction of humans. At least, any pretense of human privacy.

.telegraph.co.uk/news/worldnews/northamerica/usa/12047454/Elon-Musk-launches-1bn-fund-to-save-world-from-

dailymail.co.uk/news/article-3356608/So-terrorists-Homeland-Security-deployed-hi-tech-spy-plane-scoops-tens-thousands-phone-calls-one-time-San-Bernardino-days-massacre.

VOLATILITY WATCH

We've always been a bit amused to see how much investors love volatility when it's to the upside. When it appears in any other direction, choppy or straight to the down side, it becomes a MSM topic and something onerous if not outright sinister.

But volatility is inherent in the definition of markets. At the very least it's implied or should be. You know, sorta like the concept of marriage. Now that the Fed's set to crank up the old interest rate cycle and the market's exposed its skittish underside once again with the Dow Friday off 300 or so points, the volatility bugs are out in force warning investors like it's something new.

It ain't. But here's a sample from Reuters.

http://www.reuters.com/article/us-usa-stocks-weekahead

WILL IT STICK?

There's an old story, though we've never verified either it's origin or it's veracity, about some young Harvard guys sitting around tossing a chunk of gooey-gunk that reportedly became a best-selling toy against their office wall to see if it stuck.

From our view that's what next week's Fed rate hike--if it happens--will turn to be about. The market of course will twit and twitter over patience--that is, how much the Fed will display before further bumping up rates should their pile of trailing indicator data so dictate.

The meme being the threat  of rising rates lower stock prices. (See Friday's market selloff.) But patience is probably an incorrect term. Paralysis comes to our mind, but we're certain many Fed defenders will take issue with that. After all, after all this time, that request of the late Rodney King is still floating around out there.

With the current market worry about junk bonds safety becomes a bigger priority that might be somewhat helped by higher interest rates. The numbers on Third Avenue high yield fund tell an interesting  story. The term panic might not be an overstatement here.

According to what we've read, last summer, approximately 18 months ago, the fund had $3.5 billion in assets. As of last week it had plunged to $789 million. Some might call that a haircut. We call it, PC hall monitors aside, a scalping.

The odds on a rate hike next week have changed somewhat given Friday's big selloff in stocks and the latest high yield bond nightmare. And if you look there are other troubling signs in emerging markets, to mention just one. So the Fed, which has self-inflicted much this damned-if you-do, damned-if-you-don't scenario, will be forced to show its hand, one way or another.

As a neighbor of ours who lives and inhales the marker recently said:"It couldn't happen to nicer bunch of incompetent bureaucrats."

DEJA VU

When we view a tree what we obviously see is that part above ground. But in many trees the roots and tentacles below ground are often longer and cover a wider space than that the tree is tall.

Now that default season in the high yield bond market has been kicked off by Third Avenue, investors need to think about the sector as one of those trees. What's out there that we don't see yet and how deep and wide does it go?

One could argue that those under ground tree roots and tentacles are where the money or gold is. Any poison that manages to get into the tree must come for the most part through them. So the tree can appear healthy from the outside, but what's lurking in those hidden roots and tentacles is the most important question.

On that subject is an interesting read from zerohedge.com.

zerohedge.com/news/2015-12-12/eerie-echo-2007-it-really-bear-stearns-all-over-again

WHAT NEXT?

Rising interest rates are the topic de jour of the coming week.

And there's no paucity of gurus popping the corks on their Genie bottles. Here's one from the recent issue of Barron's, "Rising Rates Spell Stock Trouble."

I have spent a good portion of the past 25 years working with colleagues (most notably Gerald Jensen of Creighton University and Luis Garcia-Feijoo of Florida Atlantic University) to examine empirically what happens to asset classes and sectors under expansive or restrictive monetary policies.

What we have found is that there are very strong patterns of returns related to monetary policy present in the capital markets. Domestic equities perform quite well when the Fed is pursuing an expansive monetary policy, and provide more pedestrian returns in a restrictive monetary environment. This may not be a big surprise, but the magnitude of the return differences is remarkable.

The bad news first: International developed markets have followed the same general pattern as the domestic equity markets. That is, higher returns in expansive periods and lower returns in restrictive periods. It would not have paid an investor to rotate out of U.S. stocks and into foreign developed markets during restrictive periods. This is because the major financial markets are globally integrated, now more than ever before.

The good news is that developing markets show a pattern distinctly different from the U.S. and world developed markets. From 1988 through 2013 (a shorter time period due to data limitations), emerging markets earned 8.5% in expansive periods and 16.5% during restrictive periods. This makes sense in that many emerging market economies are commodity-based. It follows that emerging markets and commodity returns would follow a similar pattern. 
  
The bottom line is that Fed policy has tremendous influence on investment returns, and investors ignore Fed  policy at their peril. As Fed liftoff nears, investors would be well served to review their portfolios,. taking the Fed's expected moves as serous threats to their stock market returns
http://www.barrons.com/articles/rising-rates-spell-trouble-for-stocks.

IT"S YOUR JOB

There is a simple, straight forward disclaimer at the conclusion of this article.

All of the numbers tell us the same thing. Big trouble is ahead. My job is to inform you of these things. What you choose to do with this information is up to you.

Nearly everyone likes good news. Hardly anyone welcomes bad. For some that's what life is about. Call it ups and downs. For others their contempt for reality goes so far that they try to legislate or edit it away. These are people who love to shoot the messenger. Yet most of us don't own the bus.We're simply driving it.

These are the same people who seek to legislate away or edit legitimate differences of opinion by calling those who express them mean spirited or hateful. But facts are stubborn things, as they say. You might not like it, but there's deep, deep trouble in commodity paradise. Those are the facts.

So why are commodity prices falling so rapidly?

Many analysts are pointing to the economic slowdown in China as the primary reason.  For years, the Chinese economy voraciously gobbled up commodities from sources all over the planet, but now things are changing.  The Chinese economy is really, really slowing down, and some recently released numbers give us some clues as to the true extent of that slowdown…

-Chinese exports fell 6.8 percent in November on a year over year basis after being down 6.9 percent on a year over year basis in October.

-Chinese imports were down 8.7 percent in November on a year over year basis.

-Chinese manufacturing activity has been contracting for nine months in a row.

-Last week, the China Containerized Freight Index plummeted to 718.58 – the lowest level ever recorded.

And of course it isn’t just China.  Goldman Sachs says that the seventh largest economy on the entire planet, Brazil, has plunged into a “depression“.  And as I pointed out the other day, of the 93 largest stock market indexes in the entire world, an astonishing 47 of them (more than half) are down at least 10 percent year to date.

Even though stocks slid in the U.S. this week, the major indexes still seem somewhat stable.  But this is a bit of an illusion.  Yes, the biggest names on Wall Street are still flying high for the moment, but shares of a multitude of smaller and mid-size firms have been plummeting.  At this point, nearly 70 percent of all U.S. stocks are already below their 200 day moving averages.  This is yet another thing that we would expect to see just before the bottom falls out for stocks.

Everything that I have been writing about this week (see here and here) is perfectly consistent with all of my warnings from earlier this year.

We are plunging into a deflationary financial crisis in textbook fashion.  And if the Federal Reserve actually does decide to go ahead with an interest rate hike next week that is just going to make things even worse.

But most people are not patient enough to watch a process play out.  Most people that write about “the coming economic collapse” hype it up like it is going to be some sort of big Hollywood blockbuster that is going to happen over a week or a month and then be over.  That is definitely not the way that I see things.

To me, “the economic collapse” is something that has been happening for decades, that is still in the process of happening right now, and that will continue to happen as we move forward into the future.  The long-term trends that are ripping our economy to shreds continue to intensify, and our leaders are not doing anything to fix our underlying fundamental problems.

As the man said: We're not here to tell you whether this is a good opportunity for more failure or one for back-up-the-money truck for outright success.That's your job.

theeconomiccollapseblog.com/archives/the-global-commodity-crash-tells-us-that-a-major-deflationary-financial-crisis-is-imminent

OVERNIGHT

Reuters reports EU concern about fate of Chinese yuan and it's global impact added to the gloom in the oil patch and next week's Fed action seem to be taking their toll on investor sentiment.
 

LONDON/MILAN, Dec 11 European shares fell on Friday on concerns that weakness in the Chinese yuan could weigh on the global economy, while the slump in oil prices added to the gloomy mood before a widely expected rise in U.S. interest rates next week.

The pan-European FTSEurofirst 300 index fell 2 percent to its lowest level in around two months, and was on course for its weakest weekly perfomance since August. The euro zone's blue-chip Euro STOXX 50 index declined by a similar amount.

"We have the yuan at 4-1/2 year lows and that is causing unease in China and abroad. Last time the yuan fell like this, it caused a jolt for markets, and anyone exporting out to China, like the auto makers and luxury brands, will feel the pain from a weaker yuan," Jasper Lawler, market analyst at CMC, said.

That could hurt export-oriented companies in sectors such as automotive, luxury goods and commodities, which were among the top decliners in Europe.

Shares of French carmaker Renault, watchmaker Swatch, fashion house Hugo Boss and BHP Billiton were all down 3.3 to 5.8 percent.

The FTSEurofirst is down by 4 percent so far this week and also down 7.8 percent since the start of December, after the European Central Bank disappointed some investors with only limited new economic stimulus measures this month.

"Markets continue to discount disappointment over the ECB. You add oil prices making new lows, worries over U.S. high yield, China deflation and a mini credit crisis in Italy, then you have the cocktail that is weighing on markets," said Giuseppe Sersale, fund manager at Anthilia in Milan.

SNIFFING AROUND

 
Much has been written in the past few days since the fate of Third avenue's junk bond fun hit the news. No doubt there will be some ripples. But it obviously begs to be or not to be question for many  investors: stay or be gone?

Here's an excerpt from the recent issue of Barron's on the matter you might find interesting. Our view is best answered with a question: How good is your sniffer?

These are scary times for junk-bond investors. Not only are the bonds falling in price as commodities slump and the Federal Reserve prepares for liftoff, but tax-loss selling and large redemptions in junk-bond funds are dragging down prices further.

Investors saw one of their worst fears realized Thursday when an especially risky, money-losing, high-yield fund facing a wave of redemptions announced it is liquidating. Only by blocking the exits and setting up an orderly process for selling highly illiquid holdings does the Third Avenue Focused Credit Fund stand a chance of returning reasonable amounts of cash to investors.

Friday junk-bond exchange-traded funds, like iShares iBoxx $ High Yield Corporate Bond (ticker: HYG) fell (along with crude oil and equities) an extra-steep 2%, the worst day in more than four years. Year-to-date, the high-yield sector is down some 6%, with 3% of the loss coming in December alone.

Investors who didn’t know what they were getting into when they bought pleasant-sounding high-yield funds, may want to scale back as selling pressures intensify.

Those with long time horizons and risk appetites may find opportunity in select issues. Yields, 

especially in low, triple-C bonds, are in the high teens. “The opportunity is in the lower-quality paper where there is not a lot of liquidity,” says high-yield analyst Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors. In contrast, prices of bonds just below investment grade have improved in recent months, but they aren’t that cheap, he says.

“I wouldn’t be rushing in,” says Fridson, who expects more mutual fund outflows to pressure the sector following Third Avenue’s “unprecedented” fund liquidation. “You’d have to be awful nimble and maybe lucky to take advantage of these short-term moves.” His model shows the sector will average 3.4% annual returns for the next five years—well below coupon rates. There will be some big price swings within that long-term forecast.

Art DeGaetano, chief investment officer at Bramshill Investments, is among those sniffing for opportunity, but he’s avoiding energy-related names. “We would need to see a fairly decent repricing for us to get involved in some of the sectors that have really started to break down,” he says.
  
barrons.com/articles/high-yield-hang-in-or-bail-out