Macro and Credit - Harmonic tremor

"Stupidity is an elemental force for which no earthquake is a match." -  Karl Kraus, Austrian Writer

Watching with interest the tragedy unfold on the short gamma crowd through the demise of the short volatility ETN and ETF complex, sending markets into some tailspin and causing additional havocs in bond yields, when it came to choosing our title analogy for our post we reminded ourselves of the meaning of "Harmonic tremor". A "Harmonic tremor is a sustained release of seismic and infrasonic energy typically associated with the underground movement of magma (rising term premiums), the venting of volcanic gases from magma, or both. It's a long-duration release of seismic energy (volatility), with distinct spectral lines, that often precedes or accompanies a volcanic eruption (the demise of some short vol ETNs). More generally, a volcanic tremor is a sustained signal that may or may not possess these harmonic spectral features. Being a long-duration continuous signal from a temporally extended source, a volcanic tremor contrasts distinctly with transient sources of seismic radiation, such as tremors that are typically associated with earthquakes and explosions. Harmonic tremor is part of the four major types of seismograms, the three others being tectonic like earthquakes, shallow volcanic earthquakes and surface events. 

In this week's conversation, we would like to look at the recent sell-off which in effect was triggered by the harmonic tremor coming from the uninterrupted rise of term premiums. This regime change in volatility and the effect of "Who's Afraid of the Big Bad Wolf?" aka "inflation expectations" thanks to rising wage inflation expectations have already claimed the small fishes such as some players in the short volatility leveraged and crowded complex. Like a new grain of sand U.S. Average Hourly Earnings triggered an avalanche as seen in complex systems such as financial markets.

Synopsis:

• Macro and Credit - Rising term premium have already claimed small fishes, when are the whales going to show up?
• Final chart - Increased inflation presents a potential threat to the purchasing power of consumers.

• Macro and Credit - Rising term premium have already claimed small fishes, when are the whales going to show up?

We had hardly pressed the "publish" button for our previous post, that the events taking place in the volatility complex led to the already well publicized demise of some short volatility ETNs. This was bound to happen given the non-linearity aspect one can find in financial markets. 

The events that took place were fascinating as it was indeed yet another confirmation of our musing from February 2016 conversation "The disappearance of MS München" when we were discussing the fascinating destructive effect of "Rogue waves" on man-made "structures". Those waves have a high amplitude and may appear from nowhere and disappear without a trace, or investors in some instances. Generally rogues waves require longer time to form (like "harmonic tremors" led explosions), as their growth rate has a power law rather than an exponential one. While a 12-meter wave in the usual "linear" model has a breaking force of 6 metric tons per square meter (MT/m2), modern ships are designed to tolerate a breaking wave of 15 MT/m2, a rogue wave can dwarf both of these figures with a breaking force of 100 MT/m2. Remember this. 

Once again we would like to come back to our February post of 2016 and quote the book "Credit Crisis" authored by Dr Jochen Felsenheimer (which we quoted on numerous occasions on this very blog for good reasons) and Philip Gisdakis and steer you towards chapter 5 entitled "The Anatomy of a Credit Crisis" page 215 entitled "LTCM: The arbitrage saga" and the issue we have discussing extensively which is our great discomfort with rising positive correlations and large standard deviations move. This amounts to us as increasing rising instability and the potential for "Rogue Waves" to show up in earnest like the one experienced last Monday:

"LTCM's trading strategies generally showed no or almost very little correlation. In normal times or even in crises that are limited to a specific segment, LTCM benefited from this high degree of diversification. Nevertheless, the general flight to liquidity in 1998 caused a jump in global risk premiums, hitting the same direction. All (in normal times less-correlated) positions moved in the same direction. Finally, it is all about correlation! Rising correlations reduces the benefit from diversification, in the end hitting the fund's equity directly. This is similar with CDO investments (ie, mezzanine pieces in CDOs), which also suffer from a high (default) correlation between the underlying assets. Consequently, a major lesson of the LTCM crisis was that the underlying Covariance matrix used in Value-at-Risk (VaR) analysis is not static but changes over time." - source Credit Crises, published in 2008, authored by Dr Jochen Felsenheimer and Philip Gisdakis

You might probably understand by now from our previous sailing analogy (The Vasa ship) and wave analogy (The Ninth Wave) where it will eventually end: Another financial crisis. 

Moving back to the LTCM VaR reference, the Variance-Covariance Method assumes that returns are normally distributed. In other words, it requires that we estimate only two factors - an expected (or average) return and a standard deviation. Value-at-Risk (VaR) calculates the maximum loss expected (or worst case scenario) on an investment, over a given time period and given a specified degree of confidence. This what we had to say about VaR in our May 2015 conversation "Cushing's syndrome" and ties up nicely to our world of rising positive correlations. Your VaR measure doesn't measure today your maximum loss, but could be only measuring your minimum loss on any given day.

Check the recent large standard deviation moves dear readers such as the one experienced on the VIX last Monday and ask yourself if we are anymore in a VaR assumed "normal market" conditions:

"On a side note while enjoying a lunch with a quant fund manager friend of ours, we mused around the ineptness of VaR as a risk model. When interviewing fellow quants for a position within his fund, he has always asked the same question: What does VaR measures? He always get the same answer, namely that VaR measures the maximum loss at any point during the period. VaR is like liquidity, it is a backward-looking yardstick. It does not measure your maximum loss at any point during the period but, in today "positively correlated markets" we think it measures your "minimum loss" at any point during the period as it assumes "normal" markets. We are not in "normal" markets anymore rest assured." - source Macronomics, May 2015

But, last Monday's move while surprising by its velocity, has not been as significant as the move seen in the VIX back in 1987. We are yet to see a spike to 173 seen on the VIX during the October 1987 crash and that was something, really something.

This is also what we argued in February 2016:

If you think diversification is a "solid defense" in a world of "positive correlations", think again, because here what the authors of "Credit Crisis" had to say about LTCM and tail events (Rogue Waves):
"Even if there are arbitrage opportunities in the sense that two positions that trade at different prices right now will definitely converge at a point in the future, there is a risk that the anomaly will become even bigger. However typically a high leverage is used for positions that have a skewed risk-return profile, or a high likelihood of a small profit but a very low risk of a large loss. This equals the risk-and-return profile of credit investments but also the risk that selling far-out-of-the-money puts on equities. In case of a tail event occurs, all risk parameters to manage the overall portfolio are probably worthless, as correlation patterns change dramatically during a crisis. That said, arbitrage trades are not under fire because the crisis has an impact on the long-term-risk-and-return profile of the position. However, a crisis might cause a short-term distortion of capital market leading to immense mark-to-market losses. If the capital adequacy is not strong enough to offset the mark-to-market losses, forced unwinding triggers significant losses in arbitrage portfolios. The same was true for many asset classes during the summer of 2007, when high-quality structures came under pressure, causing significant mark-to-market losses. Many of these structures did not bear default risk but a huge liquidity risk, and therefore many investors were forced to sell." - source Credit Crises, published in 2008, authored by Dr Jochen Felsenheimer and Philip Gisdakis

You probably understand by now why we have raised the "red flag" so many times on our fear in the rise of "positive correlations". They do scare us, because they entail, larger and larger standard deviation moves and potentially trigger "Rogue Waves" which can wipe out even the biggest and most reputable "Investment ships" à la MS München." - source Macronomics, February 2016

Obviously, for us rising term premiums have been like a "harmonic tremor" leading to the buildup that ended with the explosion that occurred in the short volatility space. The catalyst has been rising inflation expectations coming from the latest U.S. Average Hourly Earnings rising 2.9% Y/Y, the most since 2009. This was the little grain of sand that triggered, we think Monday's avalanche. 

If Short Vol ETNs could be compared to a piece of a CDO like structure for the financial markets complex, they could be seen as the "Equity tranche", or the first loss piece of this "capital structure" (The tranche that absorbs the first loss (and thus is the most risky tranche) is often called an equity tranche). Obviously the next question one would like to have answered when looking at his portfolio, is am I "senior" enough in the capital structure and is my attachment point high enough to avoid the pain? 

In relation to the issue of rising term premiums and additional potential pain and "de-risking" coming we read with interest Nomura's Global Markets Navigator note from the 7th of February entitled "Rising term premium claims its first victim":

"According to the NY Fed, the 10yr UST term premium troughed in early December at -0.62bps. As of 5 February, the NY Fed estimates that it has risen 33bps to -0.29bps.

Over the same period, the MOVE Index of implied treasury volatility rose in sympathy from an all-time index low of 48 to today’s 66. In previous reports we have linked low term premia to low implied interest volatility and in turn low implied volatilities in risk assets, e.g., equities.

Front-end VIX started to rise from the first day of 2018 trading, lagging behind the increase in the term premium. It was toward the end of January that both measures began to move faster. The recent few days of trading needs little rehashing.

And yet other risk assets and measures of risk aversion have not gone through similarly violent changes. Equity volatility in the euro area and Japan rose in tandem with the US but didn’t reach the same intraday highs. High yield spreads widened too, but not in a disorderly manner. Investment grade spreads didn't move much. Indeed a simple model of daily VIX changes vs daily S&P changes would have implied that US equities should have been down nearer 11% on 5 February rather than 4%. In other words, implied has move significantly higher than realised.

There are two interpretations of these facts. First, the VIX is sending us a serious message about the outlook for short-term US equity returns that the market needs to pay attention too. Second, US equity volatility products are an asset class in their own right. The existence of levered short-vol carry positions in those markets makes them more exposed to relatively small changes in other asset classes, e.g., rates vol.

To the extent interpretation one is correct, we should see a large increase in long rates hedges and selling pressure in credit and EM. To the extent the second interpretation is correct we should expect, when the affected positions are removed, a return to the status quo ex ante. Feedback from discussions with market participants suggests most people are putting faith in the second interpretation; this was an isolated incident in an important derivatives market.

The evidence supports that case. But there’s a problem. And it's the term premium.

As we wrote last time, the cyclical growth outlook points to higher policy rates and flatter curves, tight spreads and strong equity performance. The secular improvement scenario calls for higher rates too but is ambiguous about the shape of the nominal and real curve. The ambiguity stems from uncertainty about the natural rate and inflation. This makes it hard to anchor long-end rates (without even taking into account net net issuance) – ergo higher realised rates volatilities. This uncertainty is unlikely to go away for some time if we remain in an above-trend positive output gap world.

Thus normalisation – whether cyclical or structural – means a higher term premium and higher rates volatility. Even while the absolute level of yields remains low the past few days tells us two important things: investment strategies habituated to low term premia are likely to struggle in this environment; and higher beta assets can rally as government yields rise so long as their risk premia fall faster than rates increase. If rates rise too quickly, all bets are off.

The speed and breadth of the recent recovery has left central banks with a communication problem – it is tough to forward guide a nervous bond market if inflation is rising and growth is well above trend. If a rising term premia has claimed its first victim, will there be others?

Given the low absolute level of yields there’s little case for a growth driven risk sell off. But it is the speed of the adjustment to normal that will now be critical. Perversely, the best thing for markets now would be more modest growth and comforting downside inflation miss. - source Nomura

There lie the crux of the situation, too much good news could lead to more bad news for risky assets such as the dreaded CPI number coming out soon in the US. This is a very important number for bond yields in particular and asset prices in general. 

As we stated in our previous conversation prior to the VIX bloodbath that ensued, positive correlations matter and matter a lot. On this subject we read with interest Deutsche Bank' Special Report from the 7th of February entitled "The bond risk premium and the equity/yield correlation":

"A few months ago, we noted that the combination of low yields and high equities raised concerns that a sudden rise in bond yields could lead to a material repricing of equities. A week ago, we had a glimpse of a potential shift in the equity/yield correlation (higher yields/lower equities) that has been mainly positive since the late 90s. The risk-off environment of the last couple of days has reasserted the positive correlation between bond yields and equities. How can we explain such shift in correlation?

Our analysis suggests that the equity/yield correlation is related to the bond risk premium. A high bond risk premium coincides with a negative correlation between yields and equities. In the post Volker period, 10Y UST ~3% above r* corresponds to a yield/equity correlation close to zero (on a 12m backward looking basis). Current estimates of r* are between 0 and 50bp, but are expected to rise to 50-75bp in the quarters ahead.

On this basis, assuming that inflation expectations remain broadly anchored, a persistent shift in correlation is likely to occur when 10Y UST is somewhere between 3 and 3.5%. Clearly, the market will notice a shift in correlation on a much shorter time frame: a few days of negative correlation between yields and equities have been enough to generate significant attention. Thus, one would expect the shift in correlation to be felt at lower level of rates.

The relative perception of the risk of high vs low inflation regimes – i.e. 70s stagflation vs. Japanese deflation – is likely to be the underlying driver of the equity/yield correlation. When higher inflation is negative for growth (e.g. the 70s), one would expect bond yields and equities to be negatively correlated. A positive shock to inflation would coincide with a negative shock to growth, leading to higher bond yields and lower equities. Moreover, as higher inflation will coincide with lower growth, bonds will not be a good hedge for an equity portfolio. As a result, they should command a higher risk premium. We would therefore observe a higher risk premium in bond markets and a negative correlation between bond yields and equities.

Conversely, if low inflation is negative for growth (e.g. Japan), then one would expect bond yields and equities to be positively correlated. A negative shock to inflation would coincide with a negative shock to growth. It would lead to lower bond yields and lower equities. Moreover, as lower inflation will coincide with lower growth, bonds will be a good hedge for an equity portfolio, commanding a lower risk premium. We would therefore observe a lower risk premium in bond markets and a positive correlation between bond yields and equities.

From a historical perspective, higher productivity coupled with cheap supply of labour reduced the risk of high inflation since the late 1990s. Technological advances and globalization have therefore likely been instrumental in establishing the low bond risk premium regime in place since the late 1990s.

This enabled central banks to establish their inflation targeting credentials and to be more predictable, thereby reducing interest rate volatility and the bond risk premium. Moreover, the FX regime in place in key EM economies led to  a significant increase in excess savings, which in turn depressed the bond risk premium (the bond market conundrum).

Looking ahead, the focus on inequalities in DM economies coupled with the desire of China in particular to shift towards a more consumption based economy suggest the current political economy trend is conducive to some reversal of the regime in place since the 90s, pointing towards the potential for a higher bond risk premium.

Indeed, these trends should result in (a) greater risk of trade barriers, (b) greater fiscal deficits in DM and (c) reduced current account surpluses in EM. Taken together, this should reduce the savings/investment imbalance and the disinflationary pressures from globalization. The resulting rise in the bond risk premium would put downward pressure on the yield/equity correlation.

The bond risk premium and the equities/yields correlation: the evidence

The bond risk premium (defined as the 10Y yield minus long-term growth and inflation expectations) has proven to be a good indicator of the correlation between equities and yields (defined as the rolling 12m correlation of weekly changes in the S&P and weekly changes in the 10Y yield). In the early 1990s, the bond risk premium was high and the correlation between yields and equities was negative.

Since the late 1990s, the correlation has been mostly positive with temporary exceptions around the end of tightening cycles (early 2000s and 2006) and the taper tantrum (see graphs below, note that the correlation scale is inverted on the left graph).

The focus on the post 1990s period is driven by the data availability: there are no long term growth and inflation surveys prior to this date. This period has been one of relatively stable inflation (especially relative to the 1970s), and as a result a significant portion of the move in yields can be associated to changes in the bond risk premium or a decline in the neutral real rate rather than changes in inflation. Thus, over this period, using the gap between UST10Y and the neutral real rate (as estimated by Holston, Laubach and Williams) is also a good indicator of the correlation between bond yields and equities (see graphs).

By focusing on 10Y UST – r* we can extend the sample to the early 60s. The correlation observed since the 1990s, extends over the whole lower inflation era (1986-2017). During the post Bretton Woods/high inflation/Volker periods, the correlation is weaker which could be ascribe to the fact that the 10Y rates are more impacted by inflation. Also the yield/equity correlation is always negative, which is consistent with the intuition discussed above.

In the 60s, the correlation is somewhat stronger again (see graph below).

In short, the bond risk premium is a decent indicator of the correlation between equities and bond yields. When it is high, the correlation becomes negative, pointing to high bond risk premium weighing on equities.

Assuming that inflation does not vary significantly, the gap between 10Y UST and r* can be used as a reference. Looking at the most recent samples (charts below), a spread between 10Y UST and r* of 3% would be consistent with the bond equity correlation persistently changing sign.

As well as representing a gauge of bond risk premium, the equity/yields correlation can be also used to confirm the evolution of credit risk in the euro area. Indeed, the correlation between the various European bond yields and equity markets was the same pre-crisis. In 2009, Italy switched to a persistently negative correlation which increased back towards zero following the “whatever it takes” statement from Draghi. The correlation between the CAC40 and OAT briefly turned negative when French spreads where widening substantially in 2011/2012. The shift in correlation can be interpreted as the result of a tightening of credit conditions due to a widening of credit spreads." - source Deutsche Bank

If indeed the shift in correlation from positive to negative marks a regime change in the narrative, given how loose financial conditions have been, it also indicates as per Deutsche Bank a tightening of credit conditions. To illustrate further the impact changes in cross-asset volatility thanks to change in correlations we think the below chart from Bank of America Merrill Lynch Cross-Asset Hedging note from the 7th of February entitled "Few signs of X-asset contagion as equity vol bubble finally pops" illustrate even further the "harmonic tremor":

- source Bank of America Merrill Lynch

For us, the most important piece of the puzzle for additional pain would be from the "Big Bad Wolf" aka inflation. This would generate additional pressure on risk premiums and bond yields. What matters as Nomura puts it in their note, is the speed of the adjustment and also from the Fed should it fells it is behind the curve thanks to faster than expected rise in inflation expectations. The risk obviously is on the upside particularly when it comes to rising concerns with inflation expectations. Some see the current situation with the latest US fiscal profligacy as similar to what the US experienced in the 1960s. This is the case for Deutsche Bank which sees similarities as per their Global Fixed Income note from the 9th of February entitled "A structural repricing of bond markets":

"There are some striking similarities between the new policy mix discussed above and the conditions that led to a shift upward in inflation expectations in 1966. In the first half of the 1960s, unemployment was declining rapidly but core inflation remained low and the Phillips Curve was “dead” (right graph below).

In 1966, the US administration significantly increased its fiscal spending on the back of (a) the Vietnam war and (b) the introduction of Medicare and Medicaid. This denoted a turning point in core inflation, which began to rise markedly (graph above). There are competing interpretations as to what drove the pickup in inflation: (a) fiscal stimulus, (b) non-linearities in the Phillips curve as the unemployment rate dipped below 4%, (c) rising healthcare inflation and (d) a Fed that was (ex-post) behind the curve.

Irrespective of the precise drivers, there are some similarities with current conditions. As the US economy is approaching full employment, the US government is implementing a significant fiscal stimulus. The potential introduction of trade barriers creates upside risks to inflation. Finally, the Fed may not intend to be behind the curve today, but if r* rises, as the Fed and our economists expect, current market pricing of the Fed policy will be overly accommodative." - source Deutsche Bank

There are many upside risks we commented in recent conversation, one being the start of a trade war through the implementation of trade barriers (that 30s feeling) which would put indeed some pressure on prices no doubt. This set up of both US profligacy and trade war would obviously reinforce further the bullish case for gold that led, at the end of the Vietnam to the Nixon shock in August 1971 and  the direct international convertibility of the United States dollar to gold. Could the sudden rise in positive correlations be yet another sign of the buildup in "harmonic tremor" that would led to a regime shift in inflation? We wonder.

Given as we pointed out again recently in our conversation "Bracket creep" that bear markets for US equities generally coincide with a significant tick up in core inflation, this the biggest near term concern of markets right now we think. When it comes to the relation between inflation and stock markets we read with interest Nomura's take from their Inflation Insights note from the 6th of February:

"A lesson for the near future

We think the correction in stock prices is connected to the likelihood of a return of wage inflation. We look at the traditional Gordon growth model to find that a scenario of higher wage inflation, higher inflation, higher inflation valuations, higher nominal rates and higher equity prices are very unlikely unless expectations of trend real growth substantially increase from current levels. We note that the US corporate tax cut did not manage to lift these expectations. We also note that the correction in stock prices may be a signal that US monetary policy is maybe being tightened in real terms more rapidly than what profit growth can actually sustain.

A simple framework and a reminder

According to James Bullard, President of the Federal Reserve Bank of Saint Louis, “inflation scare triggered some of the (equity) market sell-off”. There is indeed a very strong theoretical linkage between inflation and equity markets, which is best illustrated in the simple framework provided by the Gordon growth model, also referred to as the Dividend Discount Model. In this very simple model of stock prices, stock prices are discounted dividend expectations so that:

Where P is the stock price, D is future dividends and y is the nominal discount factor. Assuming a constant rate of growth for dividend g, this equation can be re-written so
that:

Yet beyond this simple formula there are various assumptions that connect stock prices to the inflation market. First, y is the discount factor for stock prices, so it is the nominal risk-free rate plus the equity premium (y=r+ep). G is the growth rate for dividends, so it is in fact the nominal growth rate of the economy multiplied by the share of economic growth that goes to profits rather than wages (g=k*gdp, with gdp the growth rate of nominal GDP). Economists call it the sharing of national income.

A key factor affecting the sharing of national income is wage inflation. Average hourly earnings increased to 2.9% year-on-year in the US nonfarm payrolls report for January – their highest growth rate since 2009. This high number was perceived as heralding the return of wage inflation in the US and therefore altering the sharing of national income towards a larger share for wages and a lower share for profits.

Clearly, this framework from 1962 does not capture some other key financial aspects of the determination of stock prices. For example, it is likely that there is some linkage between the sharing of national income and the level of the risk-free rate (k and r). If wage inflation returns, the path of nominal interest rates is likely to be higher: that was also the case recently, resulting in a higher discount factor for dividends negatively affecting stock prices. With the equity premium term already minimal (implied volatility is low), there were few reasons for investors to expect higher risk-free rates to be offset by a lower equity premium.

We view this framework as a good reminder that a scenario of higher wage inflation, higher inflation, higher inflation valuations, higher nominal rates and higher equity prices are very unlikely unless expectations of trend real growth substantially increase from current levels. It is also intriguing that the US corporate tax cut was so promptly followed by the stock price correction – which suggests at least some skepticism about its effectiveness.

A minor caveat

And there is of course a minor caveat to this framework: the risk of an inflation overshoot remains noticeably absent from inflation valuations despite the increase in wages in January. Figure 1 shows that despite an increase in the 5yr inflation swap rate, the price of a hedge against inflation much higher than 2% is not historically high. We are only cautiously long 5yr breakeven rates in the US, it is worth recalling.

Too high, too fast?

Maybe the correction in stock prices – despite the tax cut – is a sign that real rates are getting close to “neutral” levels, for example the level of the natural real rate estimated by Williams and all, is likely to exert a negative effect on growth that may go beyond what inflation conditions currently imply. In other words, absent the risk of an inflation overshoot, real rates may normalise too fast, too soon – which would have an adverse impact on the real risk-free rate, but also on real dividend growth.

- source Nomura

When it comes to inflation "expectations", the above reminds us it is all about "implied" and "realized". In similar fashion implied volatility is more simply what the market is expecting (VIX) whereas realized volatility is sometimes deemed more tangible because it reflects the actual daily movement of the S&P 500 Index. The true outlying year in history was 2008 (before 2018's sucker punch), when realized volatility was actually higher than implied volatility - the only such instance over recent years. Even in 2017 the relationship between implied volatility and realized volatility was pretty much "normal". The issue of course is that when central banks are meddling with interest rates and financial repression leads to volatility being subdued for too long, then like a coiled spring, profiting, primarily, from the "volatility premium" (the difference between implied volatility (investors’ forecast of market volatility reflected in options pricing) and realized (actual) market volatility) seems like a "sure bet" for the likes of LJM Fund Management that got beaten up big time with the VIX blowing out à la 2008 (that infamous rogue waves we talk about with a breaking force of 100 MT/m2) . Believing that the spread between implied and realized volatility would persist has indeed been a dangerous proposal with rising positive correlations. In similar fashion believing that "implied inflation" could persist remaining below "realized inflation" could become hazardous in the coming months, particularly with growing geopolitical exogenous risks around. Whereas QE was deflationary, QT could prove to be inflationary but we ramble again...

Make no mistake, inflation is the "Boogeyman" for financial markets.  A sharp pickup in inflation is likely to entail a significant re-pricing and as per our final chart below it represents a serious headwind for the US consumers (Bracket creep aside).

• Final chart - Increased inflation presents a potential threat to the purchasing power of consumers.

 The "Big Bad Wolf" aka inflation would force the hand of central banks and lead to a more rapid pace in rate hikes leading to some significant additional repricing on the way. Inflation is our concern numero uno. Our final chart comes from Wells Fargo Economics Group note from the 8th of February entitled "Is the US Consumer Running on Fumes?" and highlights the relationship between PCE Deflator and Disposable Income:

"The Threat of Higher Inflation and Higher Interest Rates

In general, higher inflation reduces the growth rate of real disposable personal income and vice versa, which is clearly demonstrated in Figure 8.

As income and wealth are affected by fluctuations in inflation, one of the biggest threats over the next several years has to do with the rate of inflation. Markets recently seem to have been spooked by the relatively, and surprisingly, strong report on average hourly earnings, which could be indicating some pressure on prices for the U.S. economy. Higher inflation means higher interest rates, and both factors are clearly negative for the U.S. consumer. Higher inflation reduces the purchasing power of income, while higher interest rates makes purchases of durable goods, which are typically financed, more expensive over time. While for those that have fixed-rate mortgages, it is music to their ears, it is bad news for those that have adjustable rate mortgages.

Although inflation has remained low in this cycle compared to its historical trend, if prices were to accelerate, Americans’ real DPI growth will, once again, slow down and could also lead to a slowing of growth in real PCE, all else equal. Therefore, if we were to see an uptick in inflation, real DPI growth will slow and consumers’ purchasing power, or the amount they could consume based on their current income, would be negatively affected. Although this effect is clearly demonstrated in Figure 8, it is also evident that DPI experiences fluctuations with rather lackluster inflation growth. That is, although higher inflation can directly decrease disposable income growth, it is not the only factor that causes reductions in the rate of growth of income.

Furthermore, increases in interest rates could contribute to a slowdown in real PCE, as consumer purchases might diminish based on increased expense, such as what we have previously mentioned associated with durable goods financing. Another sector of risk for the consumer as well as for the credit market is the tax reform’s change in second mortgages or equity lines of credit. Americans, in some circumstances, can no longer take a credit on their taxes for interest on equity lines of credit and this together with the still-high, relative to the past, delinquency rate for these lines of credit could be signaling problems ahead for the U.S. consumer, as well as for the overall credit market." - source Wells Fargo

One could argue that the only "easing" day was yesterday. Have we seen "peak consumer confidence" in the US? It certainly looks like it so beware of the Big Bad Wolf aka "inflation" because he has already blown apart the "short vol" pig's house made of straw...

"Worry is the interest paid by those who borrow trouble." -  George Washington

Stay tuned ! 

Macro and Credit - Experiments in the Revival of Organisms

"Life is obstinate and clings closest where it is most hated." -  Mary Shelley

Looking at the latest gyrations in risky markets including credit markets following our timely musing relating to "Gullibility", while thinking of our next post title we found it amusing the numerous attempts by various financial pundits in "reviving" the Phillips curve which we have been so critical of in recent conversations. For our title analogy we decided to steer towards the creepy given our title analogy refers to a 1940 Soviet motion picture which document Soviet research into the resuscitation of clinically dead organisms. It is available from the Prelinger Archives and is in the public domain. The creepy operations depicted are credited to Doctor Sergei Brukhonenko and Boris Levinskovsky who were demonstrating a special heart-lung apparatus called the autojektor (or autojector), also referred to as the heart-lung machine, to the Second Congress of Russian Pathologists in Moscow. Their modern "Frankenstein" experiments (involving decapitations) were related to the heart-lung machine. It was designed and constructed by Brukhonenko, whose work in the video is said to have led to the first operations on heart valves. The autojektor device demonstrated in the film is similar to modern ECMO machines, as well as the systems commonly used for renal dialysis in modern nephrology. The film depicts and discusses a series of medical experiments. It begins with British scientist J. B. S. Haldane appearing and discussing how he has personally seen the procedures carried out in the film and have saved lives during the war. The experiments start with a heart of canine, which is shown being isolated from a body; four tubes connected are then connected to the organ. 

You are probably asking yourselves already where we going with this creepy analogy of ours (after all being outright "scary" drives traffic for some blog pundits...), but in these Frankenstein markets to say the least, we found it amusing the attempts by so many including the PhDs are the Fed to cling on outdated models that were fit to purpose in their own time but not anymore. As pointed out by our friend Ilya Kislitskiy (@sayfuji on Twitter), resurrection is a complicated business, same thing goes with "Experiments in the Revival of Organisms":

"What can cause global anxiety? Maybe the fact that Phillips curve somewhere is "complicated" and "partially resurrecting" elsewhere? I definitely feel uncomfortable." - Ilya Kislitskiy (@sayfuji on Twitter)

Rest assured we do too, when it comes with macro old-school Phillips-curve-fans. Life is indeed obstinate, to paraphrase Mary Shelley, the author of Frankenstein. This is particularly the case with the Fed and the financial community when it comes to clinging to outdated models. It doesn't necessarily mean that these pundits' Phillips curve "autojektor device" will not eventually lead to a better model. In our book, for the time being, experiments in the revival of macroeconomic models such as the Phillips curve, defeat the purpose but we ramble again...

Also, when it comes to our analogy, Frankenstein markets comes to mind given Bondzilla, the NIRP monster has indeed become insatiable for anything with a yield. In similar fashion to Dr Frankenstein, our generous gamblers aka central bankers have become increasingly nervous with the "creatures" (or bubbles) they have spawned with their various resuscitation experiments and this is even without the exogenous geopolitical turmoil as of late. In recent years they have been doing various experiments in the revival of organisms, some European banks come to mind when we think about "zombies" in homage to recently departed horror film maverick director George A Romero. 

In this week's conversation, we would like to look at the need to continue building up your defenses in the credit space, meaning further rotation into higher quality in this overextended beta game given the accumulation of late cycle signs we are seeing.

Synopsis:

• Macro and Credit - Frankenstein markets thanks to our Modern Prometheus
• Final charts - Fun in Funds

• Macro and Credit - Frankenstein markets thanks to our Modern Prometheus

When one looks at a 70% rise in the VIX index over just three days, a 2% drop in global equities in conjunction with widening credit spreads including of course High Yield and the beta crowd, a young investor would have caught fright. But, in retrospect, this was merely a blip given our Dr Frankensteins are still busy with their central banking experiments. Obviously the big question is surrounding Bondzilla the NIRP monster, given the massive creature has been in growing in size since the start of our central bankers various iterations.

What is already starting to show credit weakness, we think is indeed coming initially from US Commercial Real Estate (CRE). Of course as we pointed out in our most recent conversation, consumer credit is another piece of the credit puzzle we watch carefully as this credit cycle unfolds and is indicative of the lateness of it.  Back in February in our conversation "Pareidolia" we pointed out the following:

"At this stage of the cycle, there is a tendency for excesses (real estate prices, subprime auto loans, etc.) to build up meaningfully. For instance, we have been monitoring the weakening demand for credit but in particular Commercial Real Estate given the latest Federal Reserve Senior Loan Officer Survey has shown that financial conditions have already started to tighten meaningfully in that space" - source Macronomics, February 2017

CRE (Commercial Real Estate) is considered to be a good proxy for the state of the economy. And, if indeed investors are pondering the likelihood that the US economic growth is slowing and that CRE valuations have gone way ahead of fundamentals, then it makes sense to track what is going on in that space for various reasons, particularly when it comes to assessing lending growth and the state of the credit cycle we think. By tracking the quarterly Senior Loan Officers Surveys (SLOOs) published by the Fed you can have a good view into credit conditions. Credit conditions for CRE have already started to tighten since a couple of quarters and from a valuation point of view, it does feel that we are close in many instances to "peak valuation". From a valuation perspective we read with interest Wells Fargo's note from the 14th of August entitled "CRE Deal Volume Shows Late-cycle behavior Q2 Chartbook" particularly the part linked to the Hotel segment of CRE:

• "Still reflecting the previous headwind of weak corporate profits and a stronger dollar, the seasonally adjusted real revenue per available room (RevPAR), which is the product of occupancy and the real average daily rate (ADR), fell to just 0.2 percent in Q2, year-over-year. That said, corporate profits were up more than 3 percent in Q1, and the dollar is softer suggesting there are some upside risks.

• Real RevPAR for higher-end hotels (luxury, upper upscale and upscale) posted its fifth straight year-over-year negative reading in six quarters in Q2, while the pace for lower-end hotels (mid- and economy-scale), has slowed significantly from its cycle peak of 8.0 percent in late-2014 to just 0.8 percent.

- Source: STR, U.S. Department of Labor, FRB and Wells Fargo Securities

Are we at "Peak Occupancy" in this rate cycles? It certainly looks this way to us. Also the negative trend in Real RevPAR growth is yet another sign that the credit cycle is slowly but surely turning we think.

It is fairly clear to us that when it comes to credit availability and lending, the CRE space indicates things are indeed slowing as per Wells Fargo's remarks from their report:

• "Senior loan officers reported that CRE lending standards tightened across the three categories while demand cooled during Q2. A net share of around 17 percent of banks, which is classified as “moderate,” reported tightening standards for construction and land development loans and multifamily.

• According to the Mortgage Bankers Association (MBA), total commercial/multifamily debt outstanding broke the $3 trillion mark in Q1. At 41 percent, commercial banks and thrifts still comprise the largest share of debt outstanding.
• Consistent with lending standards, loan growth in multifamily and construction and land development has slowed from its cycle high. Growth in income properties is also moderating.

- Source: STR, U.S. Department of Labor, FRB and Wells Fargo Securities

There are more signs from the CRE market alone that the credit cycle is slowly but surely turning and it is of course showing up in this market first.

When it comes to "Experiments in the Revival of Organisms", clearly the CRE market has reached record valuation levels as pointed out by Wells Fargo. Our Dr Frankensteins at the Fed should clearly be nervous about these lofty valuations levels we think:

"Elevated pricing (Figure 2) has also been a concern for investors, and we suspect the disconnect in pricing and transaction volume is also due to still-elevated levels of cross-border transactions.

Indeed, the low global rate environment and reach for yield, and in some cases, safe-haven plays made U.S. CRE a preferred asset class in many markets by foreign investors. With global economic conditions stabilizing, the risk of global deflation less of a concern, and hence, some major central banks expected to begin tightening monetary policy next year; investors are bracing for higher cap rates in the U.S. and abroad, and in turn, lower valuations. That said, the short and long-end of the curve are largely driven by different determinants. Moreover, cap rates don’t necessarily move in lock-step with the 10-year U.S. Treasury yield. On a global scale, the average cap rate in the U.S. in Q2 was the highest among the 11 countries tracked by RCA (e.g. France, Australia, etc.), with the risk premium still favorable at more than 400 basis points.

- Source: FDIC, Mortgage Bankers Association and Wells Fargo Securities

Sure valuation wise, as we pointed out in our most recent conversation "The Barnum effect", in these Frankenstein markets thanks to the modern Prometheus, already expensive asset classes such as European High Yield can become even more expensive thanks to central banking "Barnum effect". No doubt their Marshall amplifier can reach "11", as in the famous movie Spinal Tap. After all, as long as the Dr Frankensteins are in the game, you got to keep dancing right?

You are probably asking when the tide will be turning when it comes to the "Macro and Credit" picture. On this very subject we read with interest Barclays note from the 11th of August entitled "Macro Credit Framework: Let's be reasonable" where they update their framework for credit returns:

"With credit valuations near post-recession tights, we believe this is a good time to update our macroeconomic framework for credit returns. The core of our framework is that:

• For the purposes of forecasting credit performance, we can reduce the business cycle into two regimes: a steady state in which the economy is growing consistently and a transitional state that includes recessions plus de 12 months before and after. Macroeconomic indicators can signal which state the economy is in.
• Spreads evolve differently in the transitional state than in the steady state.
• Valuations are the key driver of returns for both steady and transitional states, but the distributions shape of those returns varies across regimes. 

- In the steady state, returns are more normal for a given valuation, and treating returns as normal should be adequate for rough estimates of returns and loss probabilities.

- Transitional state distributions are more skewed, making the distribution of expected returns rely more heavily on starting valuations.

Applying the framework to the current environment suggests a 70% chance of positive excess returns for BBB credits, with an expected return near carry (Figure 1 ). 

The macro framework suggests that we should expect 60-70bp of Six-Month Excess Returns for Corporate BBBs

Defining Business Cycle Regimes

For the purposes of making return forecasts, we believe that only two regimes really matter:

• Steady state is the default, covering periods of consistently positive economic growth that are the “expansion phase” of traditional business cycles. These phases have periods of both slower and faster growth, but without the sustained deterioration that marks a recession.
• Transitional states have been less frequent (especially in the past 30 years) and consist of recessions plus the 12 months preceding and following them.

There are number of reasons to condense the macro environment to only two regimes:

• There are clear differences in how credit returns behave in the two regimes with credit more likely to widen, and more likely to linger at wider spreads during transitional states (Figure 2).
  
  But further subdivision do not seem to add much information - for example, for a given valuation, there is not much difference in returns from "early" in a recession to "late" - so it is sensible to use fewer states.

• It makes it easier to define the conditions of being in each state, which makes it more likely that we will make the correct call. In general, we think it is relatively straightforward to understand when we are in a recession or its aftermath that means the only difficult call is whether we have moved from a steady to a transitional state.

Economic Indicators - Clue for Transitional Periods

The most challenging part of our framework is determining whether we have entered the transitional state, but we think there are useful indicators for when that happens. There are a number of layers to the process. First, the preconditions need to be in place. Then the timely indicators give us information about whether we are within the 12 months of a recession. Finally, a qualitative evaluation informs us whether our preferred signals are likely to have their usual reliability.

Preconditions for a Recession

Fed hiking cycles and tighter bank lending standards have historically been preconditions for recessions. The past six recessions have been preceded by Fed hiking cycles and leading up to the past two recessions, bank lending standards have tightened (Figures 3 and 4).

Intuitively, this makes sense - the economic benefits of looser Fed policy and accelerating lending conditions lean against the possibility of a recession.

While these indicators are necessary for a recession, they do not by themselves signal that a recession is imminent - both can be in place for multiple years before a recession begins. While these preconditions are currently being met, we must look at more timely measures that signal the economy is entering a transitional state.

Near-Term Indicators 

Jobless Claims

We believe that jobless claims are one of the best indicators of a regime shift, because they generally start to rise about a year before the economy enters a recession. This makes them particularly well timed for the move to a transitional state. Their usefulness as an indicator for credit is supported by the tendency of rising jobless claims to predict negative future returns for credit (Figure 5), consistent with our analysis that spreads generally widen from tights during the transitional state.

The decline in jobless claims has been impressive since 2009, and the measure is at all-time lows after adjusting for total jobs in the economy. With less slack in the series, the decline in claims has lost momentum, suggesting that further improvements could be limited (Figure 6).

However, claims have remained low or flat for multiple years in the past, so flattening alone is not sufficient to indicate a rise in claims. Consequently, we do not believe that jobless claims are currently signaling that we are entering a transitional period (although that assessment could change quickly).

Output Gap

The second timely indicator that we use for our macro credit framework is the output gap - a measure that Barclays Economics uses as a framework for the US business cycle (Figure 7).

The output gap uses a multivariable approach - with inputs such as working hours, output, employment, unemployment, and the labor force - to measure the actual output of the US economy versus the potential output.

We find that the output gap tends to follow the business cycle closely. The indicator typically peaks about three quarters prior to a recession, on average, and starts to roll over during the transitional state (Figure 8).

Coincidentally, spreads also tend to widen when the output gap is declining (Figure 9).

Currently, the output gap has closed and is near the 2005-2006 peak, meaning that the current business cycle is mature. However, the indicator does not seem to be rolling over and is not indicating that we are entering a transitional state yet.

Qualitative factors

In relation to position within the business cycle and whether the economy is entering a transitional period, it also makes sense to monitor qualitative factors that could pose risks to the current steady state of the economy.

Consumer Credit

Trends in consumer credit have become a cause for concern. Consumer debt outstanding has risen for credit cards, auto loans, and student loans, giving consumers less room to use debt to support spending. Delinquency rates have also begun to rise in all three cohorts (Figure 10), with the auto loan sector particularly worrisome.

Along with the significant growth in auto credits outstanding, auto loan quality has worsened, and auto sales have lost momentum. While these trends are somewhat troublesome, the size of the auto loan market pales in comparison with the mortgage market, a major issue in the last recession. And despite some deterioration in the quality of the ABS market, losses so far have been modest. Therefore, we do not believe that concerns in the auto sector will push the economy into a transitional state at the moment, but any further development should be closely monitored.

Retail sector

Weakness in retail has been a theme in 2017, with the sector facing revenue losses to e-commerce competitors and lower returns on assets because of overcapacity. Because the retail sector is such a large employer - up to 10% of American workers are in the sector in some capacity - there is a reasonable question about whether a sector restructuring could spill into the broader economy. We examined this question in greater depth in US Economics and Credit Strategy: Technology-based change leaves retail looking overextended, and our conclusion is that so far jobs are not being lost at a fast enough pace to create exogenous recession risk. For example, the number of retail workers affected by bankruptcies has increased quickly, rising above 200k over the past 18 months (Figure 11), but given that the US sees about 250k new jobless filings a week (a record low), that is not yet enough to cause broader problems.

Returns are more volatile during transitional states 

The next component of our framework is to understand what the most reasonable distribution of returns is likely to be within each state. The first thing we observe is that returns are related to starting valuations in both regimes (Figure 12).

We also note that for a given valuation, they are more volatile, and more likely to be negative, in the transitional state.

We base this analysis on Moody's data on spreads for industrial BBB long bonds. The series starts in 1919, which allows us to calibrate spread performance around 17 recessions. This is a significant advantage over using the Bloomberg Barclays Indices, which cover only three recession cycles. The disadvantage is that the Moody's data do not provide carefully structured return calculations, so we need to estimate returns using carry, spread changes (assuming the same duration as the BBB long index), and historical default rates to account for losses.

Digging a little deeper into the steady state, both returns and volatility rise consistently with starting spreads, in a very orderly relationship (Figure 14).

We also note that they look fairly normally distributed, although with some extra downside tail risk (Figure 15).

By contrast, in the transitional state, returns are less clearly related to valuation (Figure 16).

This seems to be related to more pronounced skew during these periods. But the degree and direction of skew also appear to be a function of valuation.

• When spreads have been in middle third (between 215 and 285bp), they have widened on average, but usually not enough to offset all returns from carry. As a result, the average estimated six-month return has been about 90bp. At the same time, the occurrences of large gains have been balanced fairly even against the number of large losses.
• When spreads have been the widest third (widest than 285bp), they have usually tightened, generating an average estimated six-month return of more than 200bp. They have also had higher-than-normal probabilities of large gains or tightening events." - source Barclays.

This analysis in our opinion is very interesting from a Macro and Credit perspective, as posited by our Friend Paul Buigues in his 2013 post "Long-Term Corporate Credit Returns":

"Even for a rolling investor (whose returns are also driven by mark-to-market spread moves), initial spreads explain nearly half of 5yr forward returns." - Paul Buigues, 2013

Returns are related to starting valuations in both regimes, this is a very important point for credit investors we think. Also, according to Barclays, in the transitional state, returns are less clearly related to valuation. As concluded as well in this previous 2013 by our friend Paul:

"Benjamin Graham’s famous allegory of a “Mr. Market” who alternates between periods of depression and euphoria applies especially well to corporate credit investors. In addition to having a bipolar disorder, corporate credit investors are afflicted by a severe case of myopia, as they focus on current default rates, rather than trying to estimate realistic future default rates.
As a consequence, spreads themselves are a very good indicator of long-term forward returns, for both static and rolling investors."  - Paul Buigues, 2013

Do not focus solely on the current low default rates when assessing forward credit risk. Trying to estimate realistic future default rates matter particularly when there are more and more signs showing that the cycle is slowly but surely turning in both CRE and consumer credit. Peak jobless claims and peak hotel occupancy might after all show us that we are indeed moving towards a transitional state in these Frankenstein markets. One thing for certain, the energy sector credit woes in 2016 and outperformance in the second part of 2016 was a sign that returns can be clearly related to valuation or when credit spreads reached do not make economic sense that is when average high-yield spreads above 1000bp can be irrational.

Our core thought process relating to credit and economic growth is solely based around a very important concept namely the accounting principles of "stocks" versus "flows". We have used this core principle in the past when assessing the issues plaguing Europe versus the United States as per our September 2012 conversation "Zemblanity. 

We encountered previously through our readings an essential post dealing with our core concept of "stocks versus "flows" from Mr Michael Biggs and Mr Thomas Mayer on voxeu.org entitled - How central banks contributed to the financial crisis which explains precisely why both Friedman, Keynes and the central banks have been behind the curve in preventing the previous financial crisis and potentially the next one: 

"We have argued at some length in the past that because credit growth is a stock variable and domestic demand is a flow variable, the conventional approach of comparing credit growth with demand growth is flawed (see for example Biggs et al. 2010a, 2010b).To see this, assume that all spending is credit financed. Then total spending in a year would be equal to total new borrowing. Debt in any year changes by the amount of new borrowing, which means that spending is equal to the change in debt. And if spending is equal to the change in debt, then the change in spending is equal to the change in the change in debt (i.e. the second derivative of the development of debt). Spending growth, in other words, should be related not to credit growth, but rather the change in credit growth. 

We have called the change in debt (or the change in credit growth) the 'credit impulse'. The credit impulse is effectively the private sector equivalent of the fiscal impulse, and the analogy might make the reasoning clearer. The measure of fiscal policy used to estimate the impact on spending growth is not new borrowing (the budget deficit), but rather the change in new borrowing (the fiscal impulse). We argue that this is equally true for private sector credit." - Mr Michael Biggs and Mr Thomas Mayer on voxeu.org

 We have always wondered in relation to the global rounds of quantitative easings the following:

"Does the end (lowering unemployment levels) justify the means (increasing M) or do the means justify the end (deflationary bust)?"

Credit dynamic is based on Growth. No growth or weak growth can lead to defaults and asset deflation. The change in credit growth is a flow variable and so is domestic and global demand!

As a reminder, in our part 2 conversation "Availability heuristic" from September 2015, the liabilities structure of industrial countries is mainly made up of debt (they are “short debt”), in particular in Japan, the US and the UK. In contrast, the international balance sheet structure of emerging markets is typically composed of equity liabilities (“short equity”), which is the counterpart of strong FDI inflows that contributed to improve emerging markets’ external profile in the last decade. With a rising US dollar, what has been playing out is a reverse of these imbalances hence our "macro reverse osmosis" discussed in past conversations to explain violent rotations in flows from Emerging Markets. 

As we have seen on numerous occasions, and as we have remarked in our conversation  "Critical threshold", higher yields can lead to material fund outflows. As a reminder, more liquidity = greater economic instability once QE ends. As we move towards the transitional state described by Barclays in their note, one way of "mitigating" dwindling policy support would be to "embrace" a barbell strategy. 

For our final chart, no doubt to us than in these Frankenstein markets and experiments in the revival of organisms, it has been a "Goldilocks environment" for US credit.

• Final charts - Fun in Funds

Bondzilla the NIRP monster has been created by our Dr Frankensteins in various central banks. Clearly the instigation of NIRP has put the demand for US credit from foreign investors into overdrive and it has been as we pointed out recently "Made in Japan". Our final charts come from Wells Fargo Credit Connections report entitled "Correction mode" from the 11th of August and displays fund flows relative to net share buyback:  

"Follow the Money

"Nearly $1.2 trillion of new money has flowed into U.S. Taxable Fixed Income mutual funds and ETFs since 2009. Much of that money came from Money Markets as central banks slashed cash rates and investors rotated from cash to bonds to enhance their yield. International investors jumped on the bandwagon in 2014 following the Fed’s taper tantrum, and accelerated their buying last year after European and Asian central banks cut cash rates to negative. Throughout the entire period, the lion’s share of money poured into U.S. IG credit funds. An upsurge in demand for corporate bonds allowed corporations to ramp up gross bond issuance to record levels of nearly $1.5 trillion per annum over the past six years. Much of that bond issuance was used to fund share buybacks, which helped buoy stock prices. All of this is shown in the charts above and below.

So, the $1.2 trillion question is, when does this virtuous cycle end? The short answer is, not yet as the world remains awash in excess savings and global central banks continue to pump about $200 billion of new cash into the system each month via their existing QE programs. But, we suspect the slow march back towards cash has begun. In the U.S., the Fed has raised the Fed Funds rate by 100 bps over the past 20 months to 1.25% (upper bound) and remains in tightening mode. The Wells Fargo Securities’ economists expect another hike this year, and three more next year. However, cash rates in Europe, Switzerland and Japan remain deeply negative. Until these rates are greater than zero, global excess cash will likely continue to hunt for yield enhanced investment opportunities around the world, a portion of which should flow into U.S. credit and serve as a backstop against spikes in volatility." - source Wells Fargo

As long as our Dr Frankensteins keep pumping into the system and NIRP stays firmly into play, there is no reason why asset prices cannot go even further towards the 11th mark on the Marshall amplifier of our central banks. The only creepy and scary thing with experiments in the revival of organisms is when our mad scientists will lose control of their Bondzilla, but we guess that's a story for another day while we keep monitoring the credit impulse globally and weakening signs from the US.

"Invention, it must be humbly admitted, does not consist in creating out of void, but out of chaos. " - Mary Shelley

Stay tuned !