Core meltdown

Well, that got ugly in a hurry.  Curiously, however, yesterday's risky asset selling never really seemed to reach a panicked crescendo; it was more of a drip-feed of supply into the market all day.  In that sense, it wasn't like a disaster movie or a Bond flick where the infuriatingly calm female voice intones "core meltdown in 30 seconds".   No, this was more of a Glencore meltdown, a slow descent into the void.

For clearly Glencore's travails have gone tabloid and are the new nexus of market weakness, with China's economic slowdown forgotten in a retail frenzy of Air Jordans and iPhone 6s's.  The company's swift descent into the maelstrom is the closest thing we've seen  seen to the financial crisis since the...err....financial crisis.  The familiar pattern...

Over-leverage during the good times -->  See underlying price of key asset(s) tumble  --> Share price comes under pressure as investors worry about leverage --> Devise plan to recapitalize and "sort everything out"  --> Market calls BS, equity and bond prices dump

....describes Glencore's downfall every bit as much as it did, say, Merrill Lynch's.  Certainly the price of Glencore bonds is reminiscent of crisis, be it the GFC or the biannual Greek meltdown/bailout.

source: https://twitter.com/ericbeebo/status/648516702960025600?lang=en

On a positive note, it does not seem as if Glencore carries the same systemic risk that so many financial institutions did seven years ago, most notably AIG.   Macro Man was chatting with a mate yesterday who speculated that the company's notional derivative exposure must be "in the trillions."   Macro Man's philosophy is why guess when you can look, so he did, and was pleasantly surprised by what he found.   If the company's financial statements are to be believed, the company's gross and net derivative exposure is actually quite small, and they've actually unwound about half of their book since the end of last year.

                                                  source: Glencore

That will come as small comfort to those unfortunate souls long the bonds in the chart above, of course, nor those long the equity or bonds of other commodity players, large and small.  For better or for worse, Glencore can serve as something of a morality tale of the post-crisis era, and not just because they IPO'd at the ding-dong highs of the commodity market, joining others like GS (1999) and Blackstone/KKR (2007) to cash out at the best possible time.

No, Glencore's story is one of succumbing to the temptation of the luscious fruits on offer in ZIRP-world, and the doubling of the firm's gross and net debt profiles between the end of 2011 (its first year as a public company) and 2013.   Now, this probably says as much about how management's incentives were skewed as soon as somebody else was holding the equity bag as it does about the ultra-permissive borrowing climate that's prevailed in the world of QE, ZIRP, and central bank forward guidance.  But still- adding $27 billion of gross debt is pretty punchy no matter how you slice it.

The outcome leaves the Fed in exactly the type of conundrum that curmudgeons like your author have been concerned about vis-a-vis ultra-easy monetary policy and the misallocation of capital.   Does it react to market woes deriving from Glencore by delaying the policy shift that it's indicated it wishes to get on with?  If so, isn't that kind of like delegating the chairmanship of the FOMC to Ivan Glasenberg, which doesn't seem like such a hot idea given the performance of his firm?

On the other hand, there is some legitimate stress out there.  For many of us, credit market liquidity has been a primary concern in the brave new regulatory regime, with the inability of dealers to take any principal risk rendering the market considerably more volatile...and prone to over-shooting well beyond the apparent fundamentals of the market or an underlying security.   That's all well and good if you're a long-term investor with a multi-year horizon, but in the modern climate of five minute macro, it's properly frightening for those caught long (and wrong.)  Using HYG as a proxy, high yield isn;t in proper meltdown mode yet....but it's not too far off.

As equity-focused readers have noted, biotech has gotten slammed recently, even more so than in the 'rotation, rotation, rotation' shank-fest in the .  Obviously, this is a sector quite popular with a lot of equity guys, though their performance recently does raise the question of whether they actually generate any alpha, or simply buy the thing that goes up the fastest (and not sell it when it goes down the fastest!)

Regardless, the Fed really needs to sort out its communications strategy, which has descended into farce.   You know the stream of verbal diarrhea from governors and regional presidents has become counterproductive when two Fed-heads hit the tape an hour apart giving conflicting messages.  Yes, each person around the table is special and wonderful, etc.   At such a sensitive time, however, too many cooks spoil the broth (one used to be able to say there were too many chiefs and not enough Indians- is that still allowed?)

Either way, the Fed really ought to sort itself out sooner rather than later...or we might end up with a proper core meltdown, just like you see in the Bond movies.